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Bernanke Hints at More Rate Cuts
Amid Multiple Economic Risks
By TOM BARKLEY and BRIAN BLACKSTONE
February 27, 2008 4:26 p.m.
WASHINGTON -- Federal Reserve Chairman Ben Bernanke Wednesday delivered an economic forecast fraught with risks from housing, labor and credit markets, suggesting policymakers remain on track to lower interest rates further next month.
Meanwhile, Mr. Bernanke indicated that inflation risks are more two-sided, though skewed slightly to the high side -- a nod to the stagflationary mix of weak growth and rising price data of late.
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But Mr. Bernanke made it clear where the Fed's main worries lie. "It is important to recognize that downside risks to growth remain," Mr. Bernanke told members of the House Financial Services Committee in prepared semiannual testimony on the state of the economy and monetary policy.
Fed officials "will need to judge whether the policy actions taken thus far are having their intended effects," Mr. Bernanke said, adding the central bank "will act in a timely manner as needed" to keep the economy on track.
Mr. Bernanke's remarks, which echo those he made earlier this month as well as comments Tuesday by Fed Vice Chairman Donald Kohn, suggest officials will most likely lower the federal-funds target rate at their March 18 meeting, as most economists expect. The Federal Open Market Committee has already cut the fed-funds rate at which banks lend to each other by 2.25 percentage points since September to 3%, including 1.25 percentage points over an eight-day period last month.
In Wednesday's report, the Fed noted that investors expect 100 basis points in additional rate cuts this year.
In his testimony, Mr. Bernanke offered no indication that the beleaguered housing sector is approaching a bottom. Housing should weigh on the economy "in coming quarters," Mr. Bernanke said. And one of the building sector's only bright spots last year -- nonresidential construction -- "is likely to decelerate sharply," he added.
That weakness appears to be spilling over into other sectors of the economy like consumer and business spending that had withstood the housing carnage for much of 2007.
RBS Global senior economist Michelle Girard doesn't expect a recession this year, but still has worries about the tight credit market and further falls in home prices. MarketWatch's Steve Gelsi reports.
Consumer spending "appears to have slowed significantly," Mr. Bernanke said, while higher energy prices and a weakening job market could weigh further on consumption. "The business sector has also displayed signs of being affected by the difficulties in the housing and credit markets," Mr. Bernanke said.
Financial markets, meanwhile, remain under "considerable stress," he added, and officials will monitor financial developments "closely."
In its quarterly economic forecasts released last week, the Fed downgraded its 2008 gross domestic product forecast by 0.5 percentage point to a range of 1.3% to 2%. That's even further below what officials expected back in July.
"The incoming information since our January meeting continues to suggest sluggish economic activity in the near term," Mr. Bernanke said.
Indeed, in a recent National Association for Business Economics survey, nearly half of surveyed economists think the U.S. is either already in a recession or will be this year. Mr. Bernanke's testimony made no mention of recession, though.
And he noted some bright spots, including strong business balance sheets, balanced inventories and rising exports, which Mr. Bernanke said have been helped by the lower dollar. The recently enacted fiscal stimulus package should boost growth in the second half of this year and into 2009, he added.
Mr. Bernanke was mixed on inflation. It has increased in recent months due largely to higher energy prices, Mr. Bernanke said. But looking forward, "inflation could be lower than we anticipate if slower-than-expected global growth moderates the pressure on the prices of energy and other commodities or if rates of domestic resource utilization fall more than we currently expect," Bernanke said.
Still, recent energy and commodity price gains "suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month," Mr. Bernanke said. Core inflation excludes food and energy prices. The weaker dollar is another inflation risk, he said.
But core inflation should moderate after this year, Mr. Bernanke added, since officials "expected inflation expectations to remain reasonably well-anchored and pressures on resource utilization to be muted."
Mr. Bernanke also outlined steps the Fed would like to take on deceptive mortgage practices, including a prohibition against making high-priced mortgages without "due regard" to a homeowner's ability to pay and requiring lenders to establish escrow accounts for property taxes and homeowners insurance. The proposal was released for public comment in December.
"We expect substantial public comment on our proposal, and we will carefully consider all information and viewpoints while moving expeditiously to adopt final rules," he said.
Fed Forecasts
The U.S. Federal Reserve said Wednesday it foresees a negative combination of below-trend growth and inflation rates topping 2% this year, though conditions are expected to start improving in 2009.
In its semi-annual monetary policy report to Congress, the Fed reiterated the downgraded forecasts it issued last week, for the economy to expand at a 1.3% to 2.0% pace this year, down a half-percentage point from the earlier forecast range.
The housing slump and tightening credit conditions for consumers and businesses are expected to continue to weigh on growth through this year and into 2009, with the recent rate cuts expected to return the economy to above-trend growth by 2010, it said. Gross domestic product is forecast to rise between 2.1% and 2.7% in 2009, and then increase to a 2.5% to 3.0% pace the following year.
Starting in the fourth quarter, "economic activity decelerated significantly, and the economy seems to have entered 2008 with little forward momentum," the Fed said in the report.
Tighter credit conditions for consumers and businesses have exacerbated the housing correction and weakened capital spending, the Fed said. Consumer spending has also started to be impacted by a range of factors, including "steep increases" in energy prices and falling prices in stocks and homes, it said.
The economy grew at a meager 0.6% pace in the fourth quarter, resulting in a 2.2% growth rate for all of 2007 that was the weakest in five years.
Most Fed officials see downside risk to their growth estimates, with an upward bias to their outlook for unemployment. The unemployment rate is projected to rise back above 5% this year, ending the year between 5.2% and 5.3%.
"The potential for adverse interactions, in which weaker economic activity could lead to a worsening of financial conditions and a reduced availability of credit, which in turn could further damp economic growth, could further damp economic growth, was viewed as an especially worrisome possibility," it said.
The Fed has cut its benchmark fed funds rate by 225 basis points since September, to 3%, amid signs that the troubles in the housing and financial markets are impacting the broader economy.
Investors anticipate an additional 100 basis points of easing by year-end, according to the report.
"Uncertainty about the path of policy had been very low during the first half of (2007), but it increased appreciably over the summer and generally has remained around its long-run historical average since then," the Fed said, citing the decline in Treasury yields.
The Fed has also sought to contain financial market volatility by injecting liquidity into the system through a new Term Auction Facility. Lower bid-to-cover ratios and spreads in the most recent auctions in January and February suggest the effort may be helping financial markets, it said.
Meanwhile, inflation is expected to remain above the assumed comfort zone for policymakers of 1.5% to 2%.
The Fed repeated the 2008 forecast for overall PCE inflation of 2.1% to 2.4% that it gave last week, which is above the previous estimate of 1.8% to 2.1%. The core PCE projection for this year has also been lifted to a range of 2.0% to 2.2%, from 1.7% to 1.9%.
Inflation is expected to start moderating later this year as energy prices come off their highs and the economic slowdown impacts other costs, the Fed said. Overall inflation is forecast to remain between 1.7% and 2.0% in 2009 and 2010, with nearly the same ranges for core prices.
The Fed acknowledged, however, that elevated price pressures could persist longer than expected, or that its recent easing could be "misinterpreted as reflecting less resolve" in containing inflation.
The Fed's latest report on the economic outlook accompanied Wednesday's prepared semi-annual testimony on the economy by Fed Chairman Ben Bernanke to the House Financial Services Committee.
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