WASHINGTON — The Federal Reserve is ready to cut interest rates aggressively to spur the economy, Chairman Ben Bernanke said Friday, acknowledging that economic activity appears to be slowing and "downside risks to growth have become more pronounced."
At a luncheon Thursday in Washington, Bernanke said that the protracted housing slump, the uncertainty in credit markets and falling stock prices all posed risks to consumer spending, which drives two-thirds of U.S. economic activity. He said housing starts and new-home sales were off 50 percent from their peaks and that 1 in 5 adjustable-rate mortgages for sub-prime borrowers — those with the weakest credit — were now 90 days delinquent.
"Additional policy easing may well be necessary," Bernanke said, a signal that the Fed's Open Market Committee, which sets interest rates, is likely to cut the benchmark federal funds rate by another half-point, to 3.75 percent, when it meets at the end of this month.
The federal funds rate is the rate that banks and other institutions charge one another for overnight loans, and if the Fed cuts it as expected, banks are expected to reduce their prime rates — the interest rates they charge their best customers — to 6.75 percent. For consumers, that means that rates on car and home loans and credit card debt could fall in coming months.
"We now anticipate that the FOMC will reduce its federal funds rate target by 50 basis points to 3.75 percent at the end of the month and likely to 3.5 percent at its March meeting," Bank of America economist Peter Kretzmer wrote in a note to investors. "Our baseline economic outlook is for very slow growth in the first half of 2008 but no recession."
Bernanke warned against reading too much into December's weak gains in payroll employment — just 18,000 jobs — saying that one month doesn't make a trend. Inflation remains a threat, he added, pointing to rising prices for energy and commodities.
Stocks soared after Bernanke's address, but gave back some of those gains before markets closed. The Dow Jones Industrial Average ended up 117.78 points to 12,853.09. The S&P 500 closed up 11.20 points to 1420.33.
As stocks gained, prices for next-month deliveries of oil skidded $1.96 a barrel to $93.71 on Bernanke's speech. Commodities traders feared that a slowing U.S. economy or even recession could sharply reduce the demand for oil and the products made from it.
Mainstream economists are increasing the odds of a recession — two consecutive quarters of negative economic growth — almost daily. That's based on new developments such as an announcement late Thursday by credit card giant American Express that it would take a $440 million hit against earnings last year because of rising delinquencies. The firm also predicted weaker-than-projected business this year.
"Ultimately, we probably have a recession on our hands here," said Keith Hembre, the chief economist of First American Funds, a mutual fund company based in Minneapolis.
Interest-rate cuts generally don't have much impact on the economy for a year or two, so it's doubtful that the Fed's expected action this month could head off a recession, but it might shorten a downturn and ease its sting.
President Bush and Congress continue to gauge whether and how to prepare an economic stimulus package to supplement interest-rate cuts.
Congressional Democrats and Republicans appear to agree on extending unemployment benefits and expanding food-stamp programs if a recession becomes more evident. Both are considering a onetime tax rebate, but there's less agreement on how to use tax policies to stimulate investment and spending.
In another important development late Thursday, The Wall Street Journal reported that Bank of America — one of the few big banks to avoid direct damage from the housing crisis — was negotiating to buy Countrywide Financial, the nation's largest mortgage lender. That could bring more certainty to the housing sector.
ON THE WEB
Read Bernanke's speech.
WINNERS AND LOSERS UNDER RATE CUTS
Stocks: Gain, because the cost of borrowing to invest goes down, good for 401K plans.
Bonds: Likewise, as borrowing costs go down.
Treasuries: Falling interest rates make these instruments less appealing, since investors can get better returns elsewhere.
Consumers: The cost of borrowing to buy a car, make a home repair or consolidate debt should be cheaper. This spurs consumption and economic activity.
Home building: Won't get much relief. The problem is too much supply, not borrowing.