Fed Chief Signals Rate Cut to Help Wobbly Economy, Must Keep Eye on Inflation

By JEANNINE AVERSA | AP Economics Writer

WASHINGTON (AP) - Federal Reserve Chairman Ben Bernanke warned Congress that the nation is in for a period of sluggish business growth and sent a fresh signal Wednesday that interest rates will again be lowered to steady the teetering economy.

"The economic situation has become distinctly less favorable" since the summer, the Fed chief told the House Financial Services Committee.

Since Bernanke's last such comprehensive assessment last summer, the housing slump has worsened, credit problems have intensified and the job market has deteriorated. Bernanke said the confluence of these events has turned people and businesses alike toward a more cautious attitude about spending and investment. This, he said, has further weakened the economy.

Incoming barometers continue to "suggest sluggish economic activity in the near term," Bernanke told lawmakers. At the same time, he added, the Fed must keep a close eye on inflation given the recent run-up in energy and other prices paid by consumers and businesses.

Were energy prices to continue to rise at a sharp clip - which the Fed doesn't anticipate - it would "create a very difficult problem" for the economy. It would spread inflation and would put another damper on growth, Bernanke said. If that happened, he added, it would be a "very tough situation."

For now though, the No. 1 battle is shoring up the economy, and Bernanke pledged anew to slice a key interest rate to help a struggling economy that many fear is on the verge of a recession - or possibly already in one.

The Fed "will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks," Bernanke said, hewing closely to assurances he offered earlier this month.

The central bank, which started lowering a key interest rate in September, has recently turned much more aggressive. Over the span of just eight days in January, it slashed rates by 1.25 percentage points - the biggest one-month reduction in a quarter century. Economists and Wall Street investors predict the Fed will cut rates again at its next meeting on March 18.

As Bernanke began his first day of back-to-back appearances on Capitol Hill to discuss the economy, there was more bad news on the housing and manufacturing fronts. Sales of new homes fell in January for a third straight month and orders to factories for big-ticket manufactured goods dropped in January by the largest amount in five months.

Bernanke was hopeful that previous rate reductions along with a $168 billion stimulus package of tax rebates for people and tax breaks for business would energize the economy in the second half of this year.

Bernanke has come under some criticism for not acting sooner in cutting rates to respond to the economy's problems. However, Rep. Spencer Bachus, R-Ala., offered the Fed chief some sympathy. "There is perhaps no other public figure in America who has been subjected to as much Monday-morning quarterbacking as you have over the past six months," Bachus said.

The panel's chairman, Rep. Barney Frank, D-Mass., suggested that the economy is not suffering through a garden-variety slowdown.

"I don't want to appeal to you to use the word recession, because I'm not going to be responsible for the nervous people at the stock market who overreact when you twitch your nose," Frank told Bernanke. "But the problems we now have are different."

Much of the current problems can be traced to the housing meltdown. Asked when the housing market might stabilize, Bernanke thought it possible that by "later this year it will stop being such a big drag directly" on the economy. However, house prices probably will decline into next year, he added.

"It is very difficult to know, and we've been wrong before," Bernanke said.

Even as the Fed tries to shore up the economy, it must remain mindful of inflation pressures, Bernanke said.

Record high oil prices - topping $100 a barrel - are pushing consumer prices upward. That's shrinking paychecks, and with people feeling less well off because the values of their homes have dropped, consumer spending "slowed significantly" toward the end of the year, he said.

The Fed forecasts that inflation will moderate this year compared with last year. But the Fed's recently revised inflation projection of an increase between 2.1 percent and 2.4 percent is higher than its old forecast from the fall.

"Should high rates of overall inflation persist," Bernanke said, "the possibility also exists that inflation expectations could become less well-anchored."

If people think inflation is escalating, they'll act in ways that could make things even worse, a sort of self-fulfilling prophecy. And Bernanke said that could complicate the Fed's job of trying to nurture economic growth while also keeping inflation under control.

If oil prices continue to skyrocket this year, it would be "hard to maintain low inflation," Bernanke acknowledged.

With the economy slowing and prices rising, fears are growing that the country could be headed for a bout of stagflation, a dangerous economic brew not seen since the 1970s.

Bernanke said that at some point over the course of this year, the Fed will need to "assess whether the stance of monetary policy is properly calibrated" to foster the Fed's objectives of price stability "in an environment of downside risks to growth."

With home foreclosures at record highs, the Fed has proposed rules to crack down on a range of shady lending practices that has burned many of the nation's riskiest "subprime" borrowers - those with spotty credit or low incomes - who have been hardest hit by the housing and credit debacles. The rules also would curtail misleading ads for many types of mortgages and bolster financial disclosures to borrowers.

The effectiveness of the regulations will depend on strong enforcement, Bernanke said. To that end, the Fed is working with other federal and state regulators.

A legislative proposal that would, among other things, change bankruptcy laws to allow judges to cut interest rates and reduce what's owed on troubled borrowers' mortgages could have some "conflicting effects," Bernanke warned. It could help some homeowners and hurt others because it could lead to higher interest rates in the future, he said.

Bernanke said consumers need to be financially savvy - understanding mortgages, credit cards and other financial products.

"Well they certainly need to know the interest rate and how it varies over time and what that means to them in terms of payments," Bernanke said.

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