Bernanke Gloomy, Hints at Future Rate Cuts

NEW YORK (CNNMoney.com) -- Federal Reserve Chairman Ben Bernanke predicted that the global financial markets crisis is likely to restrain the economy well into next year and signaled that the Fed may be getting ready to cut interest rates.

But he said he believes the unprecedented steps taken to have the Treasury Department and the Fed intervene in financial markets were done in time to prevent more expensive and permanent damage to the nation's leading financial institutions.

In a speech before the National Association of Business Economics in Washington on Tuesday, Bernanke said the threat of inflation has receded recently, while the economy has continued to weaken. This could be interpreted as a sign that the central bank might be preparing to lower its key fed funds rate soon.

"Overall, the combination of the incoming data and recent financial developments suggests that the outlook for economic growth has worsened and that the downside risks to growth have increased," he said.

"In light of these developments, the Federal Reserve will need to consider whether the current stance of policy remains appropriate," he added.

The fed funds rate is the primary lever the central bank uses to influence the economy. Lower rates can help reduce the borrowing costs for businesses and consumers on a wide range of loans, including business lines of credit, credit card rates and home equity loans. These cheaper loans can increase economic activity.

But lower rates can also add to inflation pressures since they tend to reduce the value of the dollar and make imported goods, most notably oil, more expensive.

The Fed cut rates seven times between September 2007 and this April, but held them steady at 2% at its past three meetings due to inflation concerns.

The Fed's next scheduled meeting is Oct. 28-29. Some investors and economists have suggested the current financial crisis could lead the Fed to announce an emergency rate cut ahead of that meeting.

Bernanke again pointed to falling housing prices as a primary cause of the problems in the nation's financial sector. But he warned "the slowdown in economic activity has spread outside the housing sector."

And he added that tighter credit conditions mean that the economic weakness is likely to continue into 2009.

"The heightened financial turmoil that we have experienced of late may well lengthen the period of weak economic performance," he said.

Bernanke defended the $700 billion bailout package passed by Congress and signed into law last week. The rescue plan will allow Treasury to buy damaged mortgage-backed securities from financial firms.

Bernanke said the bailout, as well as moves by the Fed this week to inject hundreds of billions more into the banking system and buy commercial paper used by many businesses to finance their day-to-day operations, were necessary actions to take at this time of economic stress.

"These are momentous steps, but they are being taken to address a problem of historic dimensions," he said.

And he predicted that the efforts would be successful in returning the economy into a growth path.

"The steps being taken now to restore confidence in our institutions and markets will go far to resolving the current dislocations in the markets," he predicted. "I believe that the bold actions taken...together with the natural recuperative powers of the financial markets, will lay the groundwork for financial and economic recovery."