Federal Reserve Chairman Ben Bernanke warned Congress Wednesday of a period of sluggish business growth, sending a fresh signal of another cut in interest rates.
"The economic situation has become distinctly less favorable" since the summer, Bernanke testified. Since his previous such assessment last summer, the housing slump has worsened, credit problems have intensified and the job market has deteriorated. Bernanke said the confluence of these factors has turned people and businesses alike toward a more cautious attitude toward spending and investment. This, he said, has further weakened the economy.
Incoming barometers continue to "suggest sluggish economic activity in the near term," Bernanke said in an appearance before the House Financial Services Committee. At the same time, he added, the Fed must keep a close eye on inflation given the recent run-up in energy and other prices paid by consumers and businesses.
For now though, the No. 1 battle is shoring up the economy. And Bernanke pledged anew to slice a key interest rate to steady the wobbly economy, which many fear is on the verge of a recession or possibly has already toppled into one.
The Fed "will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks," Bernanke said, hewing closely to assurances he offered earlier this month.
The central bank, which started lowering a key interest rate in September, has recently turned much more aggressive. Over the span of just eight days in January, it slashed rates by 1.25 percentage points -- the biggest one-month reduction in a quarter century. Economists and Wall Street investors predict the Fed will cut rates again at its next meeting on March 18.
There are dangers that the economy will weaken even further. "The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further," Bernanke cautioned.
The Fed chief was hopeful that previous rate reductions along with a $168 billion stimulus package of tax rebates for people and tax breaks for business will energize the economy in the second half of this year.
Even as the Fed tries to shore up the economy, it must remain mindful of inflation pressures, Bernanke said.
Record high oil prices -- topping $100 a barrel -- are pushing consumer prices upward. That's shrinking paychecks, and with people feeling less well off because the values of their homes have dropped, consumer spending "slowed significantly" toward the end of the year, the Fed chief said.
The Fed forecasts that inflation will moderate this year compared with last year. But the Fed's recently revised inflation projection of an increase between 2.1 percent and 2.4 percent is higher than its old forecast from the fall.
Bernanke said there are "slightly greater upside risks" that inflation could turn out to be higher than the Fed currently anticipates, given the recent run-up in energy and food prices.
"Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored," Bernanke warned. If people, companies and investors think inflation will move higher, they will act in ways that could turn inflation even worse, a sort of self-fulfilling prophecy. And Bernanke said that could complicate the Fed's job of trying to nurture economic growth while also keeping inflation under control.
With the economy slowing and prices rising, fears are growing that the country could be headed for a bout of stagflation, a dangerous economic brew not seen since the 1970s.
The Fed for now is focused on bolstering the economy through interest rate reductions. To combat inflation, the Fed would raise rates.
At some point over the course of this year, the Fed will need to "assess whether the stance of monetary policy is properly calibrated" to foster the Fed's objectives of price stability "in an environment of downside risks to growth," Bernanke said.
Wednesday Testimonial Signals Another Rate Cut
Fed Expected to Cut Interest Rates Again
Faced with a spreading mortgage crisis, the Federal Reserve is expected to cut interest rates for a third time later and hint that even more rate cuts could be forthcoming.
Fed Chairman Ben Bernanke has clearly signaled this outcome in a speech last month in which he said that the latest bout of financial market turbulence raised greater risks for the economy.
Most economists are expecting a quarter-point cut in the federal funds rate at Tuesday's meeting, which will be the Fed's last rate-setting discussion this year. That would push the federal funds rate down 4.25 percent and send bank's prime lending rate, the benchmark for millions of consumer and business loans, down to 7.25 percent, the lowest level in two years.
The Fed started cutting rates in September with a bolder-than-expected half-point move and then reduced the funds rate by a quarter-point at its Oct. 31 meeting. The central bank was trying to make sure that a severe slump in housing, spreading mortgage defaults and financial market turbulence which hit with force in August did not derail the economy.
In its October announcement, the Fed indicated that its two rate cuts might well be all that would be needed to make sure the country was not pushed into a recession.
But that view has undergone a dramatic about-face in the six weeks since that time, reflecting worsening conditions in financial markets and continued sharp declines in housing as lenders tighten standards in response to rising mortgage defaults.
Many analysts believe the current quarter and the early part of next year will represent the period of maximum danger for a possible recession.
"I think a full blown recession can be avoided but just barely," said David Jones, chief economist at DMJ Advisors. He predicted that the Fed will follow up its expected December rate cut with three more reductions at its first three meetings of 2008.
For all of 2008, a forecasting panel of the Securities Industry and Financial Market Markets Association said Monday it believed overall economic growth, as measured by the gross domestic product, would come in at an anemic 2.1 percent as housing construction and sales continue to fall for most of the year. That would be the weakest GDP growth in six years.
Fed to Cut Rates Next Month?
In recent speeches, two high-ranking officials from America’s Federal Reserve Bank gave conflicting indications regarding the likelihood of rate cuts next month. Both officials were deliberately ambiguous in their speeches, though one went so far as to rule out a rate cut while the other hinted at its inevitability. Nonetheless, analysts used the speeches to buttress their conclusion that a rate cut is probable. In fact, the futures market has priced in a 94% chance that rates will be cut by 25 basis points at the next meeting, on December 11. Likewise, it seems a rate cut has already been priced into the USD.
Dollar fell today
The dollar pared its gains against the euro and sterling as the bearish sentiment over the dollar does not change after Monday's unexpected dollar strength. The euro rebounded back to around 1.4250 versus the dollar, while the sterling passed through 2.05 against the dollar.
The market will focus on US housing data this week and the FOMC next week. US existing home sales due tomorrow is seen to fall from an annual rate of 5.5 million units to 5.25 million in September. Also new home sales will be released on Thursday. The housing slump will continue to weigh on the nation's economy and therefore put pressure on the Fed to cut rates.
Interest rate futures indicate that traders are pricing in a nearly 90 percent chance that the Fed will cut rates by a quarter percentage point to 4.50 percent at its Oct 31 policy meeting.
Dollar fell today
The dollar pared its gains against the euro and sterling as the bearish sentiment over the dollar does not change after Monday's unexpected dollar strength. The euro rebounded back to around 1.4250 versus the dollar, while the sterling passed through 2.05 against the dollar.
The market will focus on US housing data this week and the FOMC next week. US existing home sales due tomorrow is seen to fall from an annual rate of 5.5 million units to 5.25 million in September. Also new home sales will be released on Thursday. The housing slump will continue to weigh on the nation's economy and therefore put pressure on the Fed to cut rates.
Interest rate futures indicate that traders are pricing in a nearly 90 percent chance that the Fed will cut rates by a quarter percentage point to 4.50 percent at its Oct 31 policy meeting.
