/ 15 July 2008

Financial markets under heavy stress, says Fed chief

Restoring financial market stability is a top priority for the United States Federal Reserve as a weakening housing market, tighter credit and rising oil prices threaten the economy, Fed chairperson Ben Bernanke said on Tuesday.

”Accurately assessing and appropriately balancing the risks to the outlook for growth and inflation is a significant challenge for monetary policy-makers,” Bernanke said in remarks to the Senate banking committee. He was delivering his semi-annual testimony on economic conditions to lawmakers.

”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.

Financial markets and institutions remain under ”considerable stress”, Bernanke said.

His comments come just two days after the US Treasury Department, in close coordination with the Federal Reserve, announced measures to aid mortgage finance companies Fannie Mae and Freddie Mac, which have been under pressure as the housing market has deteriorated.

Bernanke’s comments offered little comfort to investors anxious about the economy and the health of the financial and banking sectors. US stock indexes fell to their lows of the day after his statement, while the dollar weakened and US Treasury debt prices rose as a safe-haven alternative to riskier assets.

In its semi-annual monetary policy report to the US Congress, the Fed raised its projection for growth in 2008 to a range of 1% to 1,6% from the 0,3% to 1,2% range it forecast in April on expectations of stronger consumer spending.

With energy costs moving higher, the central bank also raised its inflation forecast to a range of 3,8% to 4,2%, up substantially from its previous 3,1%-to-3,4% 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 stubbornly high inflation have put Bernanke in a tight spot as he tries to keep a lid on pricing pressures without inadvertently tipping the economy into a deep recession.

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%, since mid-September.

Shortly before Bernanke testified, government reports underlined the dilemma policy-makers face — sales at retail stores barely edged up in June but producer prices, which reflect wholesale inflation, jumped a larger-than-expected 1,8%.

News from the corporate arena was no more reassuring. General Motors, struggling with declining vehicle sales, said it will cut 20% of its salaried work force, while Kimberly-Clark cut its profit outlook because of high energy costs.

The usual policy prescription of hiking rates to curb the acceleration in prices, largely coming from costlier energy, might dampen an already sluggish pace of economic activity.

Bernanke said the Fed’s efforts to date, including the rate cuts and a series of new lending facilities, had positive effects but that 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.”

The Fed saw growth well below the economy’s potential through the rest of this year, and then strengthening gradually over the next two years. At the same time, the central bank viewed overall inflation as high, and likely to increase temporarily as higher energy prices filter through. — Reuters