Bernanke Signals Rate Cut

Economists at Goldman SachsGS and JPMorgan ChaseJPM are predicting a cut to 3.75%.

Inflation, however, remains a concern to some, making the Fed's decision about potential rate cuts "difficult," as Charles Plosser, a voting member of the Federal Open Market Committee, said in a speech Tuesday.

Plosser, the president of the Philadelphia Fed, said the central bank "must remain vigilant on the inflation front and be prepared to act as necessary to avoid the risk of undermining public confidence in the central bank's commitment to price stability," suggesting a hesitancy to cut rates.

The Bank of England and European Central Bank on Thursday held their key interest rates unchanged, also amid mounting inflation concerns.

In his speech, Bernanke said the Fed would be "closely monitoring the inflation situation." However, he said inflation expectations "appear to have remained reasonably well anchored" thus far.

Bernanke said the downside risk to growth in 2008 has worsened, highlighted by weaker demand for housing. Higher oil prices, lower equity prices and softening home values also seem likely to weigh on consumer spending, he said.

The Fed chairman called December's jobs report from the Labor Department "disappointing."

"It would be a mistake to read too much into any one report," he said. "However, should the labor market deteriorate, the risks to consumer spending would rise."

The Fed chairman used the bulk of the speech to outline how the subprime mortgage market's rise and fall contributed to the housing boom and the current tightness in the credit markets, as mortgage-related securities and other asset-backed paper became difficult to price.

He highlighted the success of the Fed's new Term Auction Facility, which injected $40 billion to the banking system in two auctions last month and plans to inject $60 billion more in two more planned for later this month, in "significantly" easing tightness in funding markets.

Bernanke said the facility could become a "useful permanent addition to the Fed's toolbox."