For the second time in as many days the head of the US Federal Reserve, Ben Bernanke, has made it clear that curtailing inflation and securing a strong US dollar are now the Fed’s highest priorities.

Bernanke’s speech was made overnight to a graduating class at Harvard, of which he is an alumnus, where he spoke extensively about the battle to control inflation, and how the campaign in 2008 was vastly different to 1975.

Central bankers do not normally comment on the value of currencies because that is left to the politicians in the finance ministries. So for Bernanke to comment on the value of the dollar on Tuesday, and to support a strong currency, was seen as a major surprise and one that has apparently surprised central banks in other major economies.

Central banks like the Reserve Bank of Australia are now faced with the prospect that the US has a publicly stated policy of wanting to see the US currency rise against other currencies, like the Aussie dollar. In the short term that won’t be too much of a problem if the change happens, and happens slowly: but if there is a rapid rise in the value of the greenback, it could very well start allowing inflationary pressures to build in economies such as Australia, New Zealand, Canada and Europe.

The strong value of the Australian dollar has helped dampen inflation over the past 15 months, especially the cost of oil imports. Our high interest rates and the buoyant outlook for resource exports over the next year will probably help maintain the dollar at current levels. But forecasts of the Australian dollar reaching parity from the likes of Westpac, the ANZ and Bank of America, are now in doubt.

Regarding inflation the Federal Reserve likes to see it in the range of 1%-2%, but it, like the RBA, has a dual policy objective: price stability on the one hand and the economy and growth on the other. Up until this point in time the seven cuts in interest rates have tried to combine both objectives since last September and the onset of the credit crunch.

Now inflation is the target and even by the Fed’s own preferred core measure, it’s around 2.4%, while consumer prices are rising at around 3.9% and producer prices are well above 7% annualised.

Bernanke’s comments left Wall Street flat after two days of fall: his comments choked off a rebound and it saw major commodities like gold, copper and oil fall. Oil finished close to $US122 a barrel and has now fallen almost 10% from its all time high last month of $US135.09. Copper fell to a three month low and gold slipped lower to around $US883 an ounce.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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