US Federal Reserve Chairman Ben Bernanke on Tuesday signalled a readiness to lower US interest rates in a dramatic shift to support an economy battered by a financial crisis of "historic dimension." Recent economic data and financial developments show the outlook for growth has worsened, Bernanke told the National Association for Business Economics.
The outlook for inflation, while still uncertain, has improved somewhat as oil and other commodity prices have eased, he added. "In light of these developments, the Federal Reserve will need to consider whether the current stance of policy remains appropriate," Bernanke said.
In opening the door to rate cuts, Bernanke is departing from the view he and other Fed officials had expressed until recently that lower rates would likely have little effect in boosting economic activity while credit markets are frozen.
The Fed cut interbank lending rates to 2.0 percent in seven steps between mid-September of last year and the end of April in a bid to put a floor under the economy. Since then, the central bank has focused on cash auctions and loans of ultra-safe Treasury securities to unlock credit markets.
The Fed's efforts at restoring credit flows by pumping hundreds of billions of dollars into the financial system have become increasingly frequent and aggressive. Earlier on Tuesday, the Fed announced a plan to buy an unspecified amount of commercial paper to ensure this common channel of short-term corporate lending remains open.
US stocks, already lower on credit worries, initially extended their decline on Bernanke's gloomy growth outlook but then pared losses. Prices for US government debt at first found support, but then slipped as stocks gained.
RATE CUT WEAPON: Many Fed officials had argued that lowering rates further would do little to spur economic activity while credit is jammed, and they have warned that with inflation already at worrisome levels, easier borrowing terms could set the stage for problems when the economy picks up.
Bernanke said the economy is poised for subdued growth during the remainder of this year and into 2009. Financial turmoil is likely to extend the weak period and increase risks to growth, he said.
"Continued efforts to stabilise the financial markets are essential," Bernanke said. "The Federal Reserve will continue to use the tools at its disposal to improve market functioning and liquidity." The Fed chair also took a softer tone on price increases, which have bedevilled the inflation-wary central bank even amid a deep housing slump and mortgage-related losses that have put financial markets into disarray.
While inflation has been elevated, prices for oil and other commodities prices have tumbled from recent peaks and import prices have fallen, Bernanke said. Further, expectations of future inflation had eased, he said, which would lessen any chance of a wage-price spiral from igniting.
"These recent developments, together with economic activity that is likely to fall short of potential for a time, should lead to rates of inflation more consistent with price stability," Bernanke said. Even so, he cautioned that commodity prices could turn sharply and said some higher costs have already become embedded in the system. "We have to be very careful not to declare victory."
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