Despite continued weakness in the housing sector and employment, inflation continues to be among the Federal Reserve’s biggest short-term concerns in determining monetary policy, Federal Reserve Chairman Ben Bernanke told Senate lawmakers today. Bernanke’s testimony before the Senate Banking Committee raises the prospect of increases in short-term interest rates in coming months if prices of oil, food and other commodities continue to rise.

Inflation has remained high, running at nearly 3.5 percent annually over the first five months of this year, Bernanke said. With gasoline and other consumer energy prices rising in recent weeks, "inflation seems likely to move temporarily higher in the near term," Bernanke said. The current high level of inflation, if sustained, "might lead the public to revise up its expectations for longer-term inflation" — expectations that could send wages and prices spiraling. "A critical responsibility of monetary policymakers is to prevent that process from taking hold," the Fed chair said.

In the long term, inflation could be kept in check by slowed economic growth. The economy continues to expand, "but at a subdued pace." Private payroll employment is falling at an average pace of 94,000 jobs per month, with employment in the construction and manufacturing sectors particularly hard hit, and the unemployment rate now stands at 5.5 percent.

Bernanke said personal consumption expenditures have held up "somewhat better than might have been expected" during the downturn, and strong export growth (fueled in part by the declining value of the dollar) "continues to be a significant boon to many U.S. companies."

The housing sector continues to weaken, Bernanke said, with declining home prices contributing to a "rising tide of foreclosures" that has "intensified the downward pressure on home prices" in some areas, particularly those that saw the largest increase in prices during the boom. Although sales of existing homes have been about the same this year, sales of new homes have continued to fall, and inventories of unsold new homes remain high, forcing home builders to scale back the pace of housing starts. 

Bernanke said he believes new rules for mortgage lenders unveiled by the Federal Reserve Monday (see story) "will help to restore confidence in the mortgage market."

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