Chairman of the U.S. Federal Reserve Board Ben Bernanke today cautioned that the outlook for economic growth is skewed to the downside, while inflation appears to be on the rise. The outlook for both remains highly uncertain however, leaving policymakers with a real challenge.

Bernanke was delivering the semi-annual monetary policy report to the Senate Committee on Banking, Housing, and Urban Affairs, saying that, “economic activity has advanced at a sluggish pace during the first half of this year, while inflation has remained elevated.”

He reported that most FOMC participants expect that, over the remainder of this year, output will, “expand at a pace appreciably below its trend rate, primarily because of continued weakness in housing markets, elevated energy prices, and tight credit conditions. Growth is projected to pick up gradually over the next two years as residential construction bottoms out and begins a slow recovery and as credit conditions gradually improve.”

However, he added that FOMC participants indicated that “considerable uncertainty surrounded their outlook for economic growth and viewed the risks to their forecasts as skewed to the downside.”

At the same time, he said that, inflation has remained high, “And, with gasoline and other consumer energy prices rising in recent weeks, inflation seems likely to move temporarily higher in the near term.”

“In their economic projections for the June FOMC meeting, monetary policy makers marked up their forecasts for inflation during 2008 as a whole,” he said. However, “FOMC participants continue to expect inflation to moderate in 2009 and 2010, as slower global growth leads to a cooling of commodity markets, as pressures on resource utilization decline, and as longer-term inflation expectations remain reasonably well anchored.”

Again, he added that, FOMC participants see “the inflation outlook as unusually uncertain and cited the possibility that commodity prices will continue to rise as an important risk to the inflation forecast. Moreover, the currently high level of inflation, if sustained, might lead the public to revise up its expectations for longer-term inflation. If that were to occur, and those revised expectations were to become embedded in the domestic wage- and price-setting process, we could see an unwelcome rise in actual inflation over the longer term.”

“At present, accurately assessing and appropriately balancing the risks to the outlook for growth and inflation is a significant challenge for monetary policy makers,” he noted. “The possibility of higher energy prices, tighter credit conditions, and a still-deeper contraction in housing markets all represent significant downside risks to the outlook for growth. At the same time, upside risks to the inflation outlook have intensified lately, as the rising prices of energy and some other commodities have led to a sharp pickup in inflation and some measures of inflation expectations have moved higher. Given the high degree of uncertainty, monetary policy makers will need to carefully assess incoming information bearing on the outlook for both inflation and growth.”

Additionally, Bernanke said, “In general, healthy economic growth depends on well-functioning financial markets. Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve.”