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The housing and credit crunch that has left the economy in a state of turmoil over the last year are `ongoing and perhaps deepening,` San Francisco Federal Reserve Bank President Janet Yellen said Thursday. She offered `favorable` prognosis on inflation, however, stating that it will likely moderate in the face of slowing economic growth.

Yellen told a meeting of the Community Leaders Luncheon in Salt Lake City, Utah, that some sources of funding have `completely dried up.`

In prepared remarks, the San Francisco Fed president reflected on an economic scenario that seemed particularly bleak, with unemployment that is on the rise and an inflation picture that is `worrisome.` However, the drop in commodity prices has relieved pressure on inflation, Yellen noted.

The Federal Reserve has been charged with the task of balancing `concerns about economic weakness with equally compelling, but conflicting, concerns about inflation,` Yellen added.

However, the recent drop in commodity prices is an encouraging sign, she said, and goes a long way to helping the Federal Reserve meet its dual mandate.

`If commodity prices keep falling—or even if they remain at current levels—the Fed`s objective of promoting both price stability and full employment will become more readily achievable,` she said.

Although she said she is still concerned with the inflation outlook, the drop in commodity prices that has been sparked by weakened demand following a slowdown in global growth `should relieve upward pressure on U.S. inflation,` Yellen predicted.

She noted that the slowing of global growth, while good for inflation, will also hit one of the few bright spots in the U.S. economy - the strength of U.S. exports.

`Lower commodity prices should also be good for U.S. economic growth, although this benefit is likely to be counterbalanced to some degree by the detrimental effects of slower foreign economic growth on our exports, which have been surging,` Yellen said.

Financial turmoil is `still alive and well, and conditions remain very fragile,` the San Francisco Fed president said. She cited the slashing of debt ratings for bond insurers like AMBAC (ABK) and MBIA, as well as the failure of IndyMac as evidence that the turmoil is still making markets difficult to navigate.

In particular, Fannie Mae (FNM) and Freddie Mac (FRE) `have suffered credit losses,` Yellen said. This, combined with tighter lending standards, resulted in a `severe economy-wide credit crunch, comparable to the one that hit the economy in the recession of the early 1990s,` she warned.

Housing prices are likely to `keep heading down for some time,` Yellen predicted.

Although second quarter GDP growth came in at a surprisingly strong 3.3 percent, Yellen warned that the `strength will not hold up,` and `economic performance will be decidedly subpar in the second half of the year.`

As the boost from the tax rebates subsides, and exports decline in the face of weakened global demand, the economy will slow, Yellen stated. Combine this with continued problems in the housing, labor, and financial markets, and GDP growth in the second half of 2008 will `come in below the growth of potential output,` she said, adding that `the unemployment rate will rise.`

On the inflation front, Yellen stated that `overall inflation over the past year has been unacceptably high.` However, she stated that the `prognosis going forward is favorable.`

`Inflation expectations remain relatively well contained, reducing the chance that a wage-price spiral will develop,` Yellen said. `Moreover, if new lower commodity prices hold, even at today`s high levels, we are likely to see improvements in overall and core consumer inflation coming through the pipeline soon.`