Fed chief suggests more rate cuts may be needed to boost economy

WASHINGTON -- Federal Reserve Chairman Ben Bernanke Tuesday suggested the central bank may have to cut interest rates to shore up a rapidly deteriorating economy and address a credit crisis of "historic dimensions."

In a speech for delivery to the National Association for Business Economics, Bernanke said that in light of a worsening economic picture, and somewhat better inflation readings "the Federal Reserve will need to consider whether the current stance of monetary policy remains appropriate."

"The Fed chairman just gave the green light for a rate cut at the October meeting, if not before," Christopher Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi, said in a note to clients.

Bernanke also warned that the economic downturn could last some time, with businesses and consumers unable to get needed credit.

"All told, economic activity is likely to be subdued during the remainder of this year and into next year," Bernanke said. "The heightened financial turmoil that we have experienced of late may well lengthen the period of weak economic performance and further increase the risks to growth."

The central bank has held its target for a key interest rate steady at 2% since the spring. In recent months, Fed officials have been in a bind, caught between slowing growth and rapidly rising inflation. In the past several weeks, however, oil and other commodity prices have fallen dramatically, while unemployment has spiked, consumer spending has slowed, and the credit crisis has spread incessantly despite numerous Fed efforts to soothe the markets, including providing hundreds of billions of dollars of low-interest loans.

Bernanke noted that the economy had shown signs of weakening even before the recent increase in financial market tensions. While he said that falling home prices and sales continued to be the primary problem in both the real economy and financial markets, he noted that "the slowdown in economic activity has spread outside the housing sector."

Rising joblessness and sluggish wages have forced consumer spending, more than two-thirds of economic activity, to "contract significantly" since May, Bernanke said. Business investment spending is under pressure.

"Even households with good credit histories are now facing difficulties in obtaining mortgage loans or home equity lines of credit. Banks are also reducing credit card limits, and denial rates on automobile loan applciations reportedly are rising," he said.

Bernanke said that slower economic growth and the recent decline in commodity prices should lead to an inflation rate closer to the level desired by the Fed. Still he cautioned that the outlook remained "highly uncertain" due to the extraordinary volatility of commodity prices, and promised to monitor the situation closely.

The Fed chairman said the $700 billion financial rescue package signed into law last week should, over time, stabilize markets and help banks and other lenders raise needed capital.

"These are momentous steps, but they are being taken to address a problem of historic dimensions," Bernanke said. "The Congress and the administration chose to act at a moment of great stress, but one at which the great majority of financial institutions have sufficient capital and liquidity to return to their critical function of providing new credit for our economy."

A growing number of economists, including those at Global Insight, UBS and First Trust Advisors, have been predicting the Fed will need to cut its target for short-term interest rates this month. The Fed next meets Oct. 28 and 29, but can change rates at any time.

Investors in a market in which participants bet on future Fed moves Tuesday morning were pricing in a half-percentage point cut, according to Action Economics.

But even some economists who are expecting a rate cut question how much it will do, given that banks are spooked to the point that they are unwilling to lend, no matter what the price is.

"It probably is something that they should do, but I wouldn't expect it to be terribly effective," says Martin Baily, an economist at the Brookings Institution who says it still could provide a psychological boost. "What we're trying to do is deal with market psychology right now."