In a dramatic change of tone, Ben Bernanke yesterday indicated that the Federal Reserve is ready to cut interest rates aggressively to ward off the risk of a US recession.
The Fed chairman said: "we stand ready to take substantive additional action as needed to support growth and to provide additional insurance against downside risks".
The language, which initially sent stocks soaring, represents a new message from the Fed, which as recently as December emphasised the uncertainty surrounding the economic outlook.
Earlier, the European Central Bank (ECB) stepped up its warnings that euro zone rates may yet rise, even though the bank's policymakers left rates unchanged at 4 per cent.
Jean-Claude Trichet, ECB president, said the bank was prepared to act "pre-emptively" to avoid excessive wage demands.
But Mr Trichet admitted that risks to the US economy were materialising and announced two fresh auctions for US dollar liquidity this month. Meanwhile, the Bank of England also left UK interest rates unchanged.
Investors said Mr Bernanke's comments in the US would reinforce expectations the Fed will cut interest rates by 50 basis points at its policy meeting this month.
"Based on what I see from the Bernanke comments, the Federal Open Market Committee is going 50 on January 30th," said Tom di Galoma at Jefferies & Co.
Mr Bernanke said: "incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced".
In the light of this new information, "additional policy-easing may well be necessary", Mr Bernanke said.
The S&P 500 index, which had been down, rallied sharply, although gains later subsided. Treasury yields pared their earlier rise, while the dollar fell against the euro, trading 0.8 per cent lower at $1.4783.
The Fed chairman said demand for housing "seems to have weakened further".
High oil prices, lower equity prices and softening home values were also likely to "weigh on consumer spending". He warned that the financial situation "remains fragile and many funding markets remain impaired".
