KEY POINTS:
Ben Bernanke, the US Federal Reserve chairman, rattled Wall Street today with a warning that the US economy was facing growing uncertainties.
His words sparked a sell- off of shares, with the US Dow Jones Industrial Average at one point falling by 140 points although it later recovered
some ground.
Mr Bernanke warned investors hoping for interest rate cuts that tackling inflation remained the top priority of the central bank as it weighed future rates policy.
In testimony to the Joint Economic Committee of Congress, Mr Bernanke stuck to his recent mantra that economic growth was likely to continue "at a moderate pace" in the months ahead.
But he said that uncertainties over the economic outlook had increased, most notably the future trend in oil prices and a possible knock-on effect from the sub-prime lending crisis into the broader US housing and credit markets.
Thus far, the Fed chairman declared, the difficulties faced by sub-prime lenders - which deal with customers who are shunned by mainstream lenders - were being contained.
He argued that the shakeout caused by defaults on mortgages by overstretched and less credit- worthy borrowers was a necessary correction after the lending excesses of the past few years.
But he warned that near-term prospects for the housing market were "uncertain," and under questioning did not rule out that problems in the sector could tip the wider economy - forecast to be growing at a pace of 3 per cent or so later in 2007 - intorecession.
Even if the demand for housing fell no further from the peak levels of the recent boom, he said in his prepared remarks, "weakness in residential construction is likely to remain a drag on economic growth" as homebuilders sought to reduce inventories of unsold homes to more normal levels.
Against this background, the sub-prime crisis had raised additional questions.
"We do know that there are risks to the central forecast," the Fed chairman conceded, warning that it was not clear how large these risks were, "and how they will materialise".
Analysts have warned that a "nightmare scenario" of falling growth in the US and rising inflation forcing the Fed to keep interest rates high could tip the global economy into recession.
Mr Bernanke's language and repeated mention of "uncertainties," was enough to spark the initial flurry of selling on Wall Street.
Another factor was his clear wish to dampen the euphoria which gripped markets last week, after the Fed held its key short-term interest rate at 5.25 per cent, but dropped from its statement the formulation indicating that the next move in rates was more likely to be up than down.
"I do want to emphasise we have not shifted away from an inflation bias," Mr Bernanke told the committee.
In the medium term, the rate of price increases was likely to decline.
Nonetheless, after slowing in the second half of 2006, core inflation (excluding volatile energy and food prices) had accelerated and remained at an "uncomfortably high" level.
Over the past 12 months, the rate had risen to 2.7 per cent from 2.1per cent a year earlier - above the central bank's assumed target inflation rate of between 2 and 2.5 per cent.
Despite this, Democrats on the committee insisted the Fed should be ready to cut rates as soon as possible, to give a fillip to the housing market.
The current adjustment might be "far from over," Charles Schumer, the New York Senator who chairs the panel said.
"Recent housing data has offered little encouragement that the market might be stabilising.
So it is still too early to tell if the worst is over for the housing market."
- INDEPENDENT