Delivering his second economic report to Capitol Hill, Bernanke also stressed that these are difficult and uncertain times for Fed policy-makers, saying the climate of slowing growth and rising inflation puts the Fed in a tricky spot in terms of setting interest rates.
"The recent rise in inflation is of concern" to Fed policy-makers, Bernanke said in prepared remarks to the Senate Banking Committee. He said that possible increases in the prices of oil as well as other raw materials "remain a risk to the inflation outlook."
"Persistently higher inflation would erode" the economy's performance "and would be costly to reverse," Bernanke added. "The Federal Reserve must take account of these risks in making its policy decisions."
On the other hand, a slowing economy should reduce inflation pressures going forward, he indicated. A slowing housing market and more cautious consumers — whose spending accounts for a big chunk of economic activity — are the main factors behind the moderation in overall economic growth, Bernanke said.
The economy which grew in the first quarter at a 5.6 percent pace, the fastest spurt in 2 1/2 years, is expected to slow to a pace of around 3 percent or less in the second half of this year.
"The extent and timing of any additional firming that may be needed to address inflation risks will depend" on what incoming barometers say about the price climate and economic activity, Bernanke said.
The Fed has been boosting interest rates since June 2004 to fend off inflation. At the Fed's last meeting on June 29, policy-makers pushed a key rate to 5.25 percent, the highest in more than five years, and the 17th rake hike. At that time, the Fed raised hopes that a respite from two years of rate pain may be in sight. Wall Street rallied.
In Wednesday's testimony, Bernanke seemed to emphasize the inflation risks facing the country. Since the Fed's June meeting, energy prices have marched high. Oil prices jumped to a record closing high of $77.03 a barrel last Friday.
Sen. Jim Bunning, R-Ky., raised concerns that the Fed will push rates too high and will hurt the economy. Bunning, who expressed opposition to Bernanke's nomination as Fed chief, said he was disappointed in Bernanke's leadership. "Inflation is not out of control," Bunning insisted. "The Fed is chasing an inflation monster that is just not there."
The Fed's next meeting is Aug. 8. Some economists believe rates will go up again then. Others think the Fed will leave them alone to assess how the economy is doing.
Before Bernanke spoke, the government said the Consumer Price Index rose by just 0.2 percent in June, the smallest increase in four months. But core inflation, which excludes energy and food, rose by 0.3 percent in June, higher than the 0.2 percent Wall Street expected. That increase left core inflation rising for the past three months at an annual rate of 3.6 percent, far above the Federal Reserve comfort zone of 2 percent or less.
Just as important as the inflation numbers is where investors and people think inflation will be heading. This inflation psychology can cause people and investors to change their behavior, making high inflation a self-fulfilling prophecy.
While recent measures of such inflation "expectations" have edged down and remain contained, Bernanke said need to be closely monitored. "The Federal Reserve must guard against the emergence of an inflation psychology" that could make a temporary increase in inflation more persistent, he said.
Bernanke's first economic report to Congress was in the middle of February, a few weeks after he took over at the Fed. The Fed's reports are issued twice a year.
In new economic projections, the Fed expects the economy to grow between 3.25 to 3.50 percent this year, as measured from the fourth quarter of last year to the fourth quarter of this year. In its old forecast in February, the Fed said it had expected growth in the range of about 3.50 percent, a decent pace.
"Core" inflation, which excludes food and energy prices, should climb this year by around 2.25 percent to 2.50 percent. The Fed's new forecast puts core inflation higher this year than the approximately 2 percent estimate it gave in February.
Bernanke took the Fed helm on Feb. 1, succeeding longtime chairman Alan Greenspan.
Fed watchers had hoped that Bernanke, a respected economist and former economics professor with a reputation for speaking plainly, would put an end to the Delphic discourse that came out of the Fed under Greenspan. However, Bernanke's communications with Wall Street and Main Street have been bumpy at times, particularly since as he sent contradictory signals early on about where interest rates might be heading.
In other business, the committee approved on a voice vote the nomination of Frederic Mishkin, a Columbia University professor an advocate of inflation targeting, to be a member of the Federal Reserve Board. His nomination is expected to be cleared by the full Senate.