It was probably the frankest assessment so far in his reign as Fed chief, and it was very grim indeed. According to Ben Bernanke, there are “significant downside risks to the outlook for growth” and the “upside risks to the inflation outlook have intensified”.

“As events in recent weeks have demonstrated, many financial markets and institutions remain under considerable stress, in part because the outlook for the economy, and thus for credit quality, remains uncertain,” Bernanke said.

That’s central bankerese for “things real crook in Tallarook” and yet, a month ago, the Fed was concerned about inflation in an economy doing better than expected and markets that rough, but were not as volatile as in March when Bear Stearns was rescued.

Now there’s bad news on the downside and bad on the upside and no middle course to steer, except to do nothing and watch the US economy continue to slow, thereby adding pressure to inflation as unemployment rises, all the while hoping that financial markets don’t tank.

It’s an enormous task and his frank warning helped send oil prices down $US9 a barrel at one stage, before a small recovery left them off $US6.45 a barrel at $US138.74. It was the biggest fall in 17 years for oil. The US dollar hit a new low against the euro, then rebounded as oil fell: the Aussie dollar charged on towards parity, topping out around 97.90 US cents on this run, yet another all time low.

Wall Street was down over 200 points at one stage, but the drop in oil helped it recover, as did improvements in some bank shares. But the shares of Freddie Mac and Fannie Mae again fell as US politicians dithered over the support package outlined on Sunday by the US Government.

US market regulators banned so-called “naked” short selling in both stocks, just as a big aggressive investors said he was shorting the shares. The US Government is determined that the two mortgage giants will not be driven into collapse by market players who will now have to hold the shares in both groups before being able to sell (via stock lending).

According to the Fed chairman, inflation is of increasing concern, but the deflationary pressures of falling asset prices and contracting credit are far more powerful, and that is now recognised by central banks around the world, including the Fed.

We can forget rate rises in the major western economies, and even China. Some emerging markets might see increases, like India, Brazil or Russia because of local issues, but Mr Bernanke’s testimony made it clear there won’t be a rate rise in the US for some time. But even then the ostriches in the US credit markets still have a 59% chance of an increase of 0.25% by the end of the year.

Coming on a day when headline US wholesale price inflation hit an annual rate of 9.2% in the year to June, the highest for 27 years, and British consumer price inflation hit an annual 3.8% rate, the highest for 16 years, we would have expected noise about possible rate rises; but the Fed chairman made clear that while inflation would rise further, those significant risks on the downside and the problems in financial markets far outweighed the need to be hairy-chested on price pressures.

New Zealand consumer inflation hit an annual rate of 4%, the highest since 1995 and the increase in the June quarter was the biggest for 18 years. In Tokyo, the Bank of Japan cut its forecast for 2009 economic growth to 1.2% from the 1.5% forecast on April 30, and lifted its consumer inflation forecast to 1.8% (excluding fresh food), compared to the 1.1% projected three months ago.

European industrial production contracted by the biggest amount in 16 years: output in the 15 nations that share the euro fell 1.9% in May from April, the biggest decline since December 1992. The annual rate fell 0.6%, the first annual decline in three years.

Mr Bernanke said US consumer spending is “likely to be restrained over coming quarters,” and businesses are “likely to be cautious with their spending in the second half of the year.” That’s him saying, don’t expect consumers or business to splash out and spend the economy back to health. It’s a message central banks in the major economies are now grimly delivering to governments and the public.

Unlike the US, Australia doesn’t have the problem of too many houses. We have the opposite problem. But in the UK overnight, more bad news with housing prices continuing to fall, while in Spain a listed property developer called Martina Fedaesa failed and sought bankruptcy protection. It was the first publicly traded developer to fail in Spain’s nasty property slump: several privately owned groups had already failed. Martina had a market cap of $US1.1 billion according to European media reports, half what it was in March.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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