Bernanke Signals Fed Will Maintain Its Outlook for Low Rates

By Craig Torres

Dec. 8 (Bloomberg) -- The Federal Open Market Committee will probably maintain its outlook for a long period of low interest rates next week as tight credit and high unemployment weigh on the economy, Fed Chairman Ben S. Bernanke signaled.

Fed officials meet for the last time this year Dec. 15-16 after a report last week showing employers cut the fewest jobs in November since the recession began in December 2007. The report prompted some investors to raise bets the Fed would increase rates by the third quarter of 2010.

Treasuries climbed yesterday after Bernanke set back those perceptions, saying the economy faces “formidable headwinds.” He repeated the language of the last Fed statement in November foreseeing an “extended period” of low rates and said inflation might subside while joblessness may fall at a pace that’s “slower than we would like.”

“Despite the positive surprise from last week’s employment report, it is way too early for the Fed to begin exiting,” said Mark Gertler, a professor of economics at New York University who worked with Bernanke on research on the Great Depression before he became Fed chairman. “When the time does come, however, the Fed will be prepared.”

Yields on two-year notes fell 7 basis points to 0.76 percent. The Standard & Poor’s 500 Index fell 0.3 percent to 1,103.25 after rising as much as 0.4 percent.

The FOMC said last month that its benchmark interest rate, which has been close to zero for a year, would remain low as long as inflation is subdued and the unemployment rate fails to decline. Bernanke said yesterday those conditions haven’t changed.

Inflation Expectations

“Right now we are still looking at the extended period given that conditions remain -- low rates of utilization, subdued inflation trends and stable long-term inflation expectations,” the Fed chief said in response to a question after a speech at the Economic Club of Washington. “That remains where we are.”

The consumer price index, minus food and energy, rose at a 1.7 percent annual pace in October, up from 1.5 percent the previous month. The core inflation rate rose at a 1.4 percent pace in August, the lowest rate since February 2004.

“We are going to have to continue to look at the economy,” Bernanke told moderator David Rubenstein, president of the economic club and co-founder of the Carlyle Group, the private equity firm. “Obviously there has been some signs of strength recently, we will want to factor that in as we talk about this next week.”

Dudley Comments

In separate remarks yesterday, New York Fed president William Dudley said the unemployment rate is “much too high.” If labor markets remain weak and inflation low, “it will be appropriate to keep the federal funds target exceptionally low for an extended period,” he told the Columbia University World Leaders Forum in New York.

Bernanke explained why the economy is unlikely to bounce back quickly. The job market “remains weak” while “bank- dependent borrowers” such as households and small business are having difficulty obtaining loans, he said. Consumer spending is “unlikely to grow rapidly” as unemployment weighs on confidence, he said.

Consumer credit in the U.S. fell by $3.51 billion, or 1.7 percent at an annual rate, to $2.48 trillion in October, according to a Fed report released yesterday. Borrowing dropped by $8.77 billion in September, less than previously estimated. Consumer credit has fallen for ninth straight months.

Growth Forecast

U.S. central bankers said last month the economy will expand in a range of 2.5 to 3.5 percent in 2010, according to the central tendency of their outlook, which excludes the three highest and three lowest projections.

That rate of growth will only drive unemployment down to a 9.3 to 9.7 percent range next year, Fed officials forecast. More than 7.2 million jobs have been lost since the start of the recession.

“We still have some way to go before we can be assured that the recovery will be self-sustaining,” the Fed Chairman said. “My best guess at this point is that we will continue to see modest economic growth next year -- sufficient to bring down the unemployment rate, but at a pace slower than we would like.”

Bernanke “certainly hasn’t done a 180 degree turn because of one payroll number,” said Michael Feroli, economist at JPMorgan Chase & Co. in New York. Risks to the economy “don’t seem balanced at all” in Bernanke’s view.

JPMorgan Chase predicts the Fed to leave interest rates unchanged until the second quarter of 2011. Feroli said that an expansion one percentage point faster than the economy’s potential growth rate, which JPMorgan estimates at around 2.25 percent, would lower then unemployment rate by around four tenths of 1 percent in a year.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net: Shobhana Chandra in Washington at +1- schandra1@bloomberg.net.

Last Updated: December 8, 2009 00:00 EST