A weakening housing market, strained
banking system and rising oil prices threaten the U.S. economy,
and restoring financial market stability is a top priority,
Federal Reserve Chairman Ben Bernanke said on Tuesday.
It was a gloomier assessment than the central bank's
policy-setting panel gave in late June, when it said risks to
growth had diminished somewhat.
Bernanke, in his semi-annual testimony on economic
conditions to lawmakers on Tuesday, acknowledged that financial
markets had grown increasingly anxious in recent weeks,
particularly over the financial condition of mortgage finance
companies Fannie Mae (FNM.N) and Freddie Mac (FRE.N).
He stressed that the outlook for economic growth and
inflation was unusually uncertain. Investors took that as a
signal that the Fed would keep interest rates unchanged at
least through August, and perhaps through the end of the year.
"The possibility of higher energy prices, tighter credit
conditions, and a still-deeper contraction in housing markets
all represent significant downside risks to the outlook for
growth. At the same time, upside risks to the inflation outlook
have intensified lately," he said.
Bernanke said the slumping housing market was "the most
critical and central issue that we face," because it held the
key to consumer spending as well as banks' financial health.
His comments come just two days after the Treasury
Department, in close coordination with the central bank,
announced measures to aid Fannie and Freddie, which have been
under pressure as the housing market has deteriorated.
Treasury Secretary Henry Paulson, in prepared testimony,
said the government-sponsored enterprises "have the potential
to pose a systemic risk" to the financial system, and urged
Congress to pass legislation creating a stronger regulator.
Paulson, Bernanke, and Securities and Exchange Commission
Chairman Christopher Cox are due to testify before the Senate
Banking Committee later on Tuesday about Fannie and Freddie.
WIDE NET
Bernanke's comments offered little comfort to investors.
U.S. stock prices fell, although they clawed back some of those
losses by late-morning as oil prices dropped. The dollar
weakened and U.S. Treasury debt prices rose as a safe-haven
alternative to riskier assets.
In its semi-annual monetary policy report to Congress, the
Fed raised its projection for growth in 2008 to a range of 1
percent to 1.6 percent from the 0.3 percent to 1.2 percent
range it forecast in April, on expectations of stronger
consumer spending.
President George W. Bush said the economy was still
growing, although he acknowledged "obvious financial
uncertainty."
With energy costs rising, the Fed also raised its inflation
forecast to a range of 3.8 percent to 4.2 percent, up
substantially from its previous 3.1 percent to 3.4 percent
projection.
"The net is now extremely wide for the Fed, with upside
inflation pressures and considerable downside growth risks,"
said Dustin Reid, senior currency strategist with ABN AMRO in
Chicago. "The Fed's having a difficult time, as are most other
central banks, as to what the next (interest rate) move should
be."
TIGHT SPOT
Sluggish economic growth and stubborn inflation have put
Bernanke in a tight spot as he tries to keep a lid on pricing
pressures without tipping the economy into a deep recession.
The usual policy prescription of hiking rates to curb the
acceleration in prices, largely coming from costlier energy,
might dampen an already slow pace of economic activity.
Pressure has grown -- both inside his policy-making
committee and out -- for the Fed to consider raising interest
rates after cutting them by 3.25 percentage points to 2 percent
since mid-September.
Shortly before Bernanke testified, government reports
underlined the dilemma. Sales at retail stores barely edged up
in June but producer prices, which reflect wholesale inflation,
jumped a larger-than-expected 1.8 percent.
News from the corporate arena was no more reassuring.
General Motors Corp (GM.N), struggling with declining vehicle
sales, said it will cut 20 percent of its salaried work force,
while Kimberly-Clark Corp (KMB.N) cut its profit outlook
because of high energy costs.
Bernanke said the Fed's efforts to date, including the rate
cuts and a series of new lending facilities, had positive
effects but the economy still faced "numerous difficulties."
"Many financial markets and institutions remain under
considerable stress, in part because the outlook for the
economy, and thus for credit quality, remains uncertain," he
said.
"Helping the financial markets to return to more normal
functioning will continue to be a top priority of the Federal
Reserve," he added.
(Additional reporting by Steven C. Johnson in New York and
David Lawder in Washington; Editing by Chizu Nomiyama)
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