Bernanke Signals Rate Cut

The Fed chairman strongly indicates further easing is coming in a speech Thursday.
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Updated from 12:37 p.m. EST

Federal Reserve

Chairman Ben Bernanke on Thursday signaled the central bank's intention to cut its key interest rate later this month.

Bernanke, in the afternoon speech to the Women in Housing and Finance and Exchequer Club Joint Luncheon in Washington, D.C., noted that the Fed's rate-setting Open Market Committee had cut the fed funds rate by a full point to 4.25% over three meetings since September.

"The Federal Reserve took these actions to help offset the restraint imposed by the tightening of credit conditions and the weakening of the housing market. However, in light of recent changes in the outlook for and the risks to growth, additional policy easing may well be necessary," he said. "The committee will, of course, be carefully evaluating incoming information bearing on the economic outlook. Based on that evaluation, and consistent with our dual mandate, we stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks."

Bernanke also said in the speech "the financial situation remains fragile, and many funding markets remain impaired" and conditions "pose a downside risk to the outlook for growth." In a question and answer session after the speech, however, he said the Fed was not forecasting a recession, only weak growth.

Bernanke's Gloom Points to More Easing

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The

Dow Jones Industrial Average

rallied almost 135 points after news of Bernanke's words leaked out ahead of its speech. More recently, the index had given up most of those gains and was up almost 16points to 12,751.

As the stock market has largely tanked so far in 2008, investors are increasingly expecting a 50-basis-point cut to the fed funds rate at the Jan. 29-30 meeting.

RealMoney.com

contributor Tony Crescenzi, the chief bond market strategist at Miller Tabak, on Wednesday reported the market is priced for 76% odds of a 50-basis-point cut.

Economists at

Goldman Sachs

(GS) - Get Report

and

JPMorgan Chase

(JPM) - Get Report

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."

This article was written by a staff member of TheStreet.com.