Bernanke Says More Interest-Rate Cuts May Be Needed (Update)

By Craig Torres and Scott Lanman

(Bloomberg) -- Federal Reserve Board Chairman Ben S. Bernanke said more interest-rate cuts ``may well be necessary'' after 1 percentage point of reductions since September to buttress economic growth.

``We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks,'' Bernanke said today in his first speech on the economy since the Fed's Dec. 11 meeting. Recent figures suggested the outlook for ``2008 has worsened and the downside risks to growth have become more pronounced,'' he said.

The comments increased speculation that the Federal Open Market Committee will cut its benchmark rate by half a percentage point, to 3.75 percent, this month. Wall Street analysts say the odds of a recession have increased after a report last week showed a jump in unemployment.

``A number of factors, including higher oil prices, lower equity prices, and softening home values, seem likely to weigh on consumer spending'' this year, Bernanke said in remarks to the Women in Housing and Finance and Exchequer Club in Washington.

The Fed isn't forecasting a recession, the Fed chief said in response to a question after the speech. ``We are forecasting slow growth, but there are downside risks,'' he added. ``It is important to take substantive action against those risks.''

Bigger Reduction

``From the tone of the speech, a 50-basis point cut seems likely,'' Lawrence Lindsey, a former economic adviser to President George W. Bush and ex-Fed governor, said from New York. Though it's ``unlikely'' the U.S. is in recession, Bernanke ``is quite right to take precautionary measures right now,'' he said.

The dollar extended declines and shorter-dated Treasuries rallied after Bernanke's remarks, while stocks initially rose before dropping. Yields on two-year Treasuries fell to 2.65 percent at 2:13 p.m. in New York, from 2.72 percent late yesterday. The dollar dropped 0.9 percent to $1.48 per euro.

``The committee 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,'' Bernanke said.

Futures prices indicate the odds of a half-point rate cut on Jan. 30 jumped to 90 percent today from 76 percent yesterday and 34 percent a week ago. Futures show a 100 percent chance of at least a quarter-point reduction.

`Clear Signal'

``It is a clear signal of a changing economic forecast at the Federal Reserve,'' said Richard Hoey, chief economist at Bank of New York Mellon Corp.

The FOMC has cut the benchmark rate 1 percentage point to 4.25 percent since September to offset the drag from tighter lending conditions and prolonged housing slump.

Goldman Sachs Group Inc. economists yesterday predicted the Fed will lower the rate to 2.5 percent by year-end. The bank joined Merrill Lynch & Co. and Morgan Stanley in projecting a recession.

Residential investment has declined for seven consecutive quarters, and Fed officials say it may take at least six more months before housing markets turn. Delinquency rates on subprime mortgages climbed to 16.3 percent in the third quarter, the highest in at least a decade.

``The demand for housing seems to have weakened further, in part reflecting ongoing problems in mortgage markets,'' Bernanke said. ``We also see considerable evidence that banks have come more restrictive in their lending to firms and households.''

Unemployment Rises

Payrolls rose by 18,000 last month, capping the worst year for job creation since 2003. The unemployment rate rose to 5 percent from 4.7 percent the previous month.

Bernanke called the December jobs report ``disappointing,'' while cautioning that it would be ``a mistake to read too much into any one report.''

``However, should the labor market deteriorate, the risks to consumer spending would rise,'' he added.

Bernanke said the Fed's new tool to alleviate bank funding strains may be made permanent. The Fed last month introduced the so-called Term Auction Facility to auction funds to banks beyond the overnight horizon in the federal funds market. The central bank sold $40 billion in two auctions last month and plans $60 billion in two operations in January.

The TAF may ``become a useful permanent addition to the Fed's toolbox,'' Bernanke said. He also said the TAF operations and the ``passage'' of a jump in year-end funding demands caused financial strains to ease ``significantly,'' though spreads remain above the levels before August.

Inflation Pressure

The Fed chairman said higher oil costs were likely to lift inflation measures, including those excluding food and fuel.

The Fed's preferred gauge of consumer prices rose 2.2 percent in November from a year before, the most since March.

Inflation expectations measured by yield differences on 10- year Treasuries and government inflation-indexed bonds have remained between 2.2 percent and 2.4 percent over the past year, a sign that investors have confidence the central bank will maintain price stability.

``Any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and reduce the central bank's policy flexibility to counter shortfalls in growth in the future,'' Bernanke said.

Fed officials predict the personal consumption expenditures price index, minus food and energy, to rise 1.7 percent to 1.9 percent this year. Crude oil futures reached a record $100.09 barrel on Jan. 3. Oil prices are up 72 percent from a year ago.