June 10 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said policy makers will ``strongly resist'' any surge in inflation expectations, delivering his clearest message yet the central bank is done lowering interest rates.

Bernanke played down the biggest jump in the unemployment rate in 22 years in May and said the risk of a ``substantial downturn'' receded in the past month. Policy makers will need to pay ``close attention'' to make sure the increase in commodity costs doesn't pass through to broader consumer prices, he said in a speech to a Boston Fed conference late yesterday.

The Fed chief's remarks spurred investors to bet that officials will raise rates later this year. Two-year note yields approached their highest level this year in New York trading, and stocks fell. Bernanke and his colleagues are raising the alarm on inflation after oil costs doubled in the past year and companies from Dow Chemical Co. to tire-maker Titan International Inc. raised prices.

Bernanke's comments ``represent a significant shift,'' said Bruce Kasman, chief economist at JPMorgan Chase & Co. There's the possibility of ``an earlier Fed adjustment than we are now projecting, currently the second quarter of 2009.''

Two-year Treasury yields, more sensitive to Fed rate expectations than longer-dated notes, climbed 12 basis points to 2.83 percent as of 9:53 a.m. in New York. Traders anticipate the central bank will keep its target rate at 2 percent this month and raise it as soon as September, futures prices indicate. The Standard and Poor's 500 Index was down 0.5 percentage point.

`Destabilizing' Threat

Central bankers ``will strongly resist an erosion of longer-term inflation expectations,'' Bernanke said yesterday at the Boston Fed's annual economic conference in Chatham, Massachusetts. Any public anticipation of accelerating price gains ``would be destabilizing for growth,'' he said.

The Fed's communications ``have to make sure that people understand'' that officials are ``going to do the right thing in terms of controlling long-run inflation,'' Federal Reserve Governor Frederic Mishkin said at the conference today.

A measure of investors' forecast for consumer price gains in the coming 10 years, derived from the difference in yield between Treasuries and Treasury notes linked to inflation, stood at 2.56 percent. The gap has averaged about 2.06 percent in the past decade.

A gauge of household expectations for inflation over five years climbed to a 13-year high last month, according to a Reuters/University of Michigan Survey.

`Complicated Balance'

The Fed faces a ``complicated balance'' of lowering interest rates to avert a recession ``without taking too much risk that underlying inflation is going to accelerate over time,'' New York Fed President Timothy Geithner said in New York yesterday.

The New York Fed, the central bank's main link with Wall Street, also yesterday announced an agreement with banks on changes aimed at easing the risk of a collapse of the $62 trillion market for credit-default swaps.

Seventeen banks that handle about 90 percent of the trading in the market will create a system to move trades through a clearinghouse that would absorb a failure by one of the market- makers, the New York Fed said.

Geithner said yesterday in his speech that ``our first and most immediate priority remains to help the economy and the financial system get through this crisis.''

Benchmark Rate

Fed officials have cut the benchmark lending rate to 2 percent from 5.25 percent in September. They next meet June 24- 25.

The consumer price index rose 3.9 percent in the 12 months ending in April, up from a 2.6 percent gain a year ago. Energy costs have spurred the gains. AAA, the largest U.S. motoring group, said this month that gasoline surpassed an average of $4 a gallon (3.79 liters) for the first time. Oil prices reached a record $139.12 on June 6.

``We need to proceed in a very deliberate manner and I expect us to do so,'' Dallas Federal Reserve President Richard Fisher said in a speech today in New York. ``You don't want central banks with trigger fingers.''

Bernanke said ``the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.'' While risks to growth were still to the ``downside,'' he added that federal tax rebates, past rate cuts and record exports should underpin the expansion.

Figures `Unwelcome'

The unemployment rate rose to 5.5 percent in May, the most in more than two decades, as the U.S. lost jobs for a fifth month. Bernanke called the jobless figures ``unwelcome,'' though he added that recent economic data had ``only modestly'' affected the outlook for growth and employment.

``Inflation has remained high, largely reflecting sharp increases in the prices of globally traded commodities,'' Bernanke said. Though ``the pass through of high raw materials costs to the prices of most other products and to domestic labor costs has been limited,'' officials will need to monitor for any change in the situation, he said.

``The comments suggest that the Fed's bias is now shifting to inflation concern and that this shift will be reflected in the June 25th FOMC statement,'' Kasman said. JPMorgan will wait for Vice Chairman Donald Kohn's comments Wednesday at the conference before changing its federal funds forecast, he said.

European Central Bank President Jean-Claude Trichet yesterday repeated that policy makers in the 15-nation euro area may next month raise their benchmark rate a quarter point to 4.25 percent to combat the fastest inflation in 16-years.

``I did not exclude that we could increase by a small amount,'' Trichet said in Paris, noting he ``never said'' some on the governing council were in favor of a series of rate increases.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Scott Lanman in Washington at slanman@bloomberg.net.

Last Updated: June 10, 2008 10:55 EDT