Federal Reserve Bank of San Francisco President Janet Yellen said Monday market conditions "could get worse before they get better", but that she expects market functioning to "improve markedly" by 2009.

Speaking at the University of California in San Diego, Yellen said inflation risks have "definitely" increased and that the housing sector will likely face more "unpleasant changes."



She said policy is now at a crossroads as it faces competing risks between inflation and growth, though the Fed president said she is "somewhat reassured" by recent data showing no signs of general wage pressure.

"On balance, I still see inflation expectations as reasonably well anchored and I anticipate that consumer survey measures will come down once oil and food prices stop rising," she said. "But the risks to inflation are likely not symmetric and they have definitely increased. We cannot and will not allow a wage-price spiral to develop."

Yellen added that a worst-case scenario for the economy has been avoided.

By Stephen Huebl and edited by Nancy Girgis