Federal Reserve Chairman Ben Bernanke signaled the US central bank would act to strongly resist rising inflation, as energy costs soar into the stratosphere.
Bernanke also played down a May surge in the unemployment rate from 5.1% to 5.5%, the biggest jump in 22 years, saying the risks of a substantial downturn in the US economy had receded.
His remarks suggest inflation is featuring more prominently on the Fed's radar screen, indicating policy-makers have little intention to cut interest rates further. Average gasoline prices in the United States have just surpassed $4 a gallon for the first time.
"The latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations," Bernanke said at a conference organized by the Boston Federal Reserve.
"The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation," Bernanke said.
The dollar jumped to a three-month high against the yen and US Treasuries tumbled after Bernanke's remarks.
Bernanke's inflation warning, the third in just one week, seemed to bring him closer to the more inflation-leery faction of the policy-setting Federal Open Market Committee, led by the presidents of the Dallas and Philadelphia Federal Reserve Banks, Richard Fisher and Charles Plosser.
Fisher told CNBC on Monday that a weak dollar could lead to a vicious cycle of higher inflation and weaker growth.
Still, analysts have been skeptical that tough talk on price growth would be followed up with real action in the form of higher interest rates.
Rate futures have begun pricing in the prospect of a rate hike as early as October, but some are skeptical as to whether the Fed's warnings on the dollar and inflation have any teeth, particularly at time when banks continue to reel from bad investments in the mortgage sector.
For his part, Bernanke appeared relatively sanguine about the economic outlook, more so than he had been just a couple of months back.
"Although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so," he said
The speech also pointed to rising nervousness at the Fed over recent surges in oil prices, which have pushed crude oil reached a record over $139 a barrel last week.
US inflation rose 3.2% in the 12 months to April, and by 2.1% over the same period when volatile food and energy costs were excluded, according to the Fed's preferred inflation report, the government's personal income data.
The Federal Open Market Committee next meets on June 24-25. Financial markets largely expect the Fed will not begin to raise interest rates until its October meeting.
Bernanke said inflation remains high, reflecting commodities price rises. At the same time, he said, higher raw materials costs have yet to translate to higher prices for products or the need to raise worker pay in response.
But the Fed chairman cautioned there is no guarantee this will remain the case.
"The continuation of this pattern is not guaranteed, and future developments in this regard will bear close watching," he said.
Bernanke sounded a softer tone on worries about weak growth, saying that recent data had "only modestly" affected the Fed's view that the economy will regain strength later this year after a weak start.
US gross domestic product expanded at a weak 0.9% annual rate in the first three months of the year, after a sluggish 0.6% annual rate in the final quarter of last year, the effects of the bursting of the US housing bubble and a credit crunch triggered by a spike in mortgage delinquencies.
The economy still faces difficulties from the housing downturn and escalating energy costs, Bernanke said.
At the same time, the Fed's rate cuts, which have taken benchmark borrowing costs down to 2% from 5.25% in September, government rebate checks sent to taxpayers, and signs of healing in battered financial markets provide "some offset" to headwinds still facing the economy, the Fed chairman said.
The central bank also plans to continue measures aimed at helping financial markets recover.
"We have taken a number of actions to promote financial stability and remain strongly committed to that objective," he said.
Bernanke's renewed focus on inflation was accompanied by an attempt to distance the central bank from the use of futures markets to predict the direction of commodity prices.
"Futures markets have often underpredicted commodity price increases in recent years, leading to corresponding underpredictions of overall inflation," he said.
"The poor recent record of commodity futures markets in forecasting the course of price raises the question of whether policy-makers should continue to use this source of information."
The central bank had continuously forecast a stabilization in rising energy costs that never materialized. (Reuters)