US vows stability by further trimming rates

Bernanke boosted markets on Thursday. While delivering his speech, he gave a glimpse of a possible sharp rate trim.

Federal Reserve Chairman Ben Bernanke on Thursday said the U.S. central bank was ready to act aggressively to counter a deep housing slump and credit market strains that were putting economic growth at risk.

"In light of recent changes in the outlook for and the risks to growth, additional policy easing may be necessary," Bernanke told an event sponsored by two finance groups.

"We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks," he said.

Analysts welcomed Bernanke's forthright acknowledgment of the dangers faced by the U.S. economy, which some fear may have already slipped into recession.

"I think he's come to terms with the fact that while inflation may be a concern down the road, he has to take care of the train that's coming at him right now, which is the fear of a recession," said Angel Mata, managing director of listed equity trading at Stifel Nicolaus Capital Markets in Baltimore, Maryland.

Bernanke cautioned that conditions can change quickly.

That meant the Fed "must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability."

U.S. stock markets initially surged after Bernanke's comments but later retreated, before turning higher again on a report that Bank of America was in talks to buy mortgage lender Countrywide Financial Corp.

At the same time, the dollar weakened and prices for short-term government debt rose, as investors bet the Fed would lower benchmark overnight rates by a hefty half-percentage to 3.75 percent at a meeting on Jan. 29-3O.

Interest-rate futures contracts shifted to price in a near certainty of a half-point cut. The Fed already has cut rates a full percentage point since mid-September.

FOCUS ON GROWTH

Bernanke suggested policy-makers now were more worried about sustaining growth than they were fearful of inflation. He said inflation expectations were "reasonably well anchored" and pledged to monitor those expectations closely.

But Kansas City Fed President Thomas Hoenig sounded a different note in a speech in Kansas City on Thursday, describing himself as "less pessimistic than some" and still wary of rising prices.

Hoenig was one of five regional Fed presidents who sat on the central bank's policy-making committee last year but he does not get a vote on interest rates in 2008.

Bernanke cited several factors, including higher oil prices, lower stock prices and falling home values, that he said were bound to hurt consumer spending this year.

"Incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced," he said. He cited "considerable evidence that banks have become more restrictive in their lending" to consumers and businesses.

But he told a questioner the economy would likely dodge recession. "The Fed is not currently forecasting recession ... we are forecasting slow growth," Bernanke said.

JOB REPORT SHOCKS

He said a report last Friday that showed only 18,000 jobs were created in December was a clear sign of mounting economic risks. "Should the labor market deteriorate, the risks to consumer spending would rise," Bernanke said.

He said still-unsettled financial markets were a concern and it was not yet clear the extent of losses that banks and other market participants face as mortgage defaults mount.

But Bernanke said banks had gone into the current unsettled situation in good shape and should be able to weather it.

"Notwithstanding the effects of multibillion-dollar write-downs on the earnings and share prices of some large institutions, the banking system remains sound," he said. "Nevertheless, the market strains have been serious and they continue to pose risks to the broader economy."

He said rising foreclosures on subprime mortgages were making lenders wary about extending credit to anyone, not just those with spotty credit histories, spreading the impact of the housing downturn more broadly throughout the economy.

Bernanke said the Fed's recent introduction of a special auction facility to inject liquidity into the banking system by selling credit was showing results. The intent is to encourage banks to keep lending and Bernanke said the auctions may be made permanent.