Bernanke Moves Closer to Rate Cut as Risks to Economy Intensify

By Scott Lanman and Craig Torres

Sept. 25 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke moved closer to cutting interest rates, signaling that risks to U.S. growth are greater than policy makers saw them just last week.

The ``intensification'' of the financial crisis in recent weeks is curbing Americans' access to borrowing, making the outlook for consumer spending ``sluggish at best,'' Bernanke told lawmakers in Washington yesterday. While he noted that risks to inflation remain, the Fed chief's testimony focused on ``grave threats'' to the banking system.

``It opens the door a bit further for rate cuts, although it doesn't signal that the committee is at that point already,'' said former Fed researcher Brian Sack, now senior economist at Macroeconomic Advisers LLC in Washington. ``It still seems like it would take a further deterioration in financial conditions or in the data to prompt a rate cut.''

Bernanke's assessment reflected further disruptions to money markets since the central bank met Sept. 16, when the Federal Open Market Committee left the benchmark rate at 2 percent. The three-month London interbank offered rate, or Libor, a benchmark for confidence in the banking system, jumped the most in eight years today.

Traders increased bets on a quarter-point rate cut at or before the FOMC's Oct. 28-29 meeting, sending the probability implied in futures contracts to 80 percent yesterday from 58 percent the previous day.

`Coming Back'

``Increasingly, the odds favor the Fed coming back and easing again,'' said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut. The FOMC cut rates seven times from September 2007 to April.

Still, interest-rate futures proved false in anticipating last month's decision, when the FOMC kept the main rate unchanged at 2 percent for a third meeting. Bernanke has shown a preference for separating monetary policy from efforts to increase liquidity and help financial markets function.

The Fed chief used his description of the dangers to the economy in trying to persuade lawmakers yesterday to support Treasury Secretary Henry Paulson's $700 billion plan for the government to remove devalued assets from the financial system.

Fed policy makers last week said tighter credit would ``weigh'' on growth, and consumer spending was ``softening.'' By contrast, Bernanke yesterday said that without congressional passage of Paulson's plan, the economy's performance may be damaged ``over perhaps a period of years.''

Growth Slows

Bernanke's testimony yesterday before the Joint Economic Committee signaled that restrictive credit has now slowed the economy from its 3.3 percent annualized pace in the second quarter to a pace ``appreciably below its potential rate.''

The Fed chief later joined Paulson for a House Financial Services Committee hearing yesterday to discuss the proposed financial rescue.

Fed officials have so far failed to stem the credit crisis even after the steepest rate cuts in two decades and interventions in Bear Stearns Cos. and American International Group Inc. this year. The Fed also backed the Treasury's action this month to take over Fannie Mae and Freddie Mac as the turmoil engulfed the two largest mortgage finance companies.

The central bank has also pumped billions of dollars into banks to try to restore liquidity, while invoking emergency powers to loan to securities firms. This week, the Fed expanded agreements with central banks abroad to offer dollars in overseas markets, providing up to $30 billion for Australia, Sweden, Norway and Denmark.

Fed Strategy

``We still think that they're going to leave the funds rate at 2 percent and try to address the specific market problems with liquidity provisions,'' said Stephen Stanley, chief economist at RBS Greenwich Capital Markets. The Fed will leave rate unchanged ``barring an absolute cataclysm in the economy and/or financial markets,'' said Stanley, a former economist at the Richmond Fed.

The crisis has intensified even with the Fed's cash injections, with banks hesitant to lend to each other on concern more institutions will fail.

Three-month Libor, a rate banks charge each other for loans in dollars, rose to 3.77 percent from 3.48 percent today, the biggest jump since 1999, British Bankers' Association data showed today.

Lawmakers at both hearings yesterday pressed Bernanke to explain better how the crisis would affect average Americans, such as constituents who were calling and writing to oppose what some termed a bailout for Wall Street.

In a worsening credit crisis, ``people cannot borrow to buy a car, to send a student to college, to buy a house,'' Bernanke told the House committee. Scant lending harms ``people at the lunch-bucket level,'' he said.

``Bernanke was refreshingly frank, open and honest about the economic outlook in a way that has been uncommon in his tenure,'' said Joseph Brusuelas, chief economist at fund manager Merk Investments LLC in Palo Alto, California.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net