Fed Chairman: housing a drag on US growth into 2008

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Bernanke Says Housing to Remain `Drag' on U.S. Growth Into 2008

By Craig Torres and Scott Lanman

 

Oct. 16 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said

the housing industry's contraction will be a ``significant drag'' on

U.S. growth into next year, though evidence of a broader impact on

spending is limited.

 

``It remains too early to assess the extent to which household and

business spending will be affected,'' Bernanke said in a speech to

the Economic Club of New York late yesterday. The Fed ``will

continue to watch the situation closely and will act as needed to

support efficient market functioning and to foster sustainable

economic growth and price stability,'' he added.

 

Bernanke, as Vice Chairman Donald Kohn did two weeks ago, pointed

out risks to both growth and inflation, declining to signal whether

he favors lower interest-rates. Investors pared expectations for a

cut this month after retail sales and jobs increased in September,

suggesting consumers are weathering the worst housing slump since

1991 and reduced access to credit.

 

The Fed last month indicated that it was ``totally symmetric''

toward reducing or holding rates after its first reduction in four

years, said Alan Blinder, a former Fed vice chairman and current

Princeton University professor who attended the dinner. ``I don't

think anyone here heard anything to change that view.''

 

Credit markets have improved, while a full recovery will take time

``and we may well see some setbacks,'' Bernanke said in his first

speech on the economy since August.

 

The dollar and Treasuries were little changed in Asian trading after

Bernanke's remarks. The U.S. currency was at $1.4202 per euro at

9:16 a.m. in Tokyo, from $1.4198 late in New York yesterday, and 10-

year Treasury notes yielded 4.68 percent, unchanged from the U.S.

close.

 

Rate Cut

 

The Federal Open Market Committee lowered its benchmark rate by a

half point to 4.75 percent on Sept. 18, the first cut in four years,

to protect the U.S. from sinking into a recession sparked by fallout

from the housing-market collapse.

 

Futures contracts on the Chicago Board of Trade indicate a 32

percent chance the central bank will cut the overnight lending rate

between banks a quarter-percentage point at its Oct. 31 meeting,

compared with 48 percent odds a week ago.

 

Answering questions after his speech, Bernanke said while central

banks can't be ``indifferent'' to exchange rates, data show the

effect of a falling dollar on prices is ``relatively small.'' The

U.S. trade deficit, which has narrowed for three straight month, has

yet to see the full impact of the dollar's decline, he also said.

 

Fed's Decision

 

Bernanke's speech described the events leading up to the Fed's

discount rate cut in August and half-point cut in the benchmark

lending rate Sept. 18, and the thinking behind policy makers'

actions. The September reduction exceeded most economists'

forecasts.

 

``Risk management considerations also played a role in the decision,

given the possibility that the housing correction and tighter credit

could presage broader weakening in economic conditions that would be

difficult to arrest,'' he said.

 

The Fed chief said the sell-off in credit markets exposed the

``weakness'' in newly engineered financial products. Investors now

find it difficult to value the instruments, he said, urging firms to

be clear in how they calculate their worth.

 

``I would like to know what those damn things are worth,'' Bernanke

joked when asked by Henry Kaufman, the former Salomon Brothers Inc.

economist who is treasurer of the Economic Club of New York, what

information he would need for more effective policy making.

 

`Take a While'

 

``This current financial stress is not likely to disappear

overnight'' Bernanke said. ``It is going to take a while for

investors to appropriately value these assets.''

 

The economy's performance so far this year ``has been reasonably

good,'' and evidence ``has been limited'' that the housing recession

is hurting household spending, Bernanke said.

 

At the same time, there are signs that the job market is

``cooling,'' and Fed policy makers will be watching household and

business spending along with payroll and income changes, he said.

 

Bernanke said the risks of a larger cut in rates last month seemed

acceptable because inflation figures were ``favorable'' in recent

months. He also said that the FOMC ``was prepared to reverse the

policy easing if inflation pressures proved stronger than

expected.''

 

Kohn said in an Oct. 5 speech that policy makers must be ``nimble''

in setting rates given the risks of both a slower expansion and

faster inflation.

 

Since the September cut, signs of increasing liquidity in capital

markets encouraged investors to question whether the Fed would keep

lowering rates.

 

Liquidity Returns

 

The market for commercial paper expanded for a second straight week

through Oct. 10 and speculative-grade corporate bond sales have also

resumed. The gap in rates between mortgages of more than $417,000

and those below has declined to 0.64 percentage point, from about 1

percentage point a month ago.

 

While acknowledging improvement in some markets, Bernanke said

``conditions in mortgage markets remain difficult'' and subprime

mortgage delinquencies may increase further.

 

``Bernanke steered clear from giving any firm indication of the next

step for monetary policy,'' said Michael Feroli, economist at

JPMorgan Chase & Co. in New York.