The US Federal Reserve is ready to ease monetary policy further if economic growth and inflation slow much more, chairman Ben Bernanke said today, giving a boost to the bruised stock market.
While holding to a view that recent economic softness would eventually pass, he appeared less confident in that projection and more willing to entertain the possibility of another round of stimulus.
"The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support," Mr Bernanke told the US House of Representatives Financial Services Committee.
Mr Bernanke specifically noted the Fed's forecasts in June, already revised down significantly from April, had not incorporated recent data, particularly last Friday's dismal employment report. It showed job growth essentially ground to a halt in May and June while the jobless rate rose to 9.2 per cent.
Hopes for further monetary support sent US stocks, which have taken a drubbing over the last week on worries about Europe's debt troubles and a soft US economy, 1 per cent higher, while Treasury bond prices and the dollar tumbled.
Asked whether the Fed would be willing to launch another bond purchase program if the economy slumps, Mr Bernanke said: "We have to keep all the options on the table. We don't know where the economy is going to go."
Embarking on a path of further stimulus would not be simple. The second, $600 billion bond buying programme, which ended in June, raised eyebrows both at home and abroad when it was first announced back in November.
Republicans and some economists accused the Fed of laying the groundwork for future inflation, while leaders in emerging economies accused the Fed of a backdoor dollar devaluation.
Pressed on the budget, Mr Bernanke reiterated his warning that a failure to raise the. debt ceiling would deal a severe blow to the global economic recovery.
"Cutting programmes or raising taxes in ways that will reduce aggregate demand ... is going to slow the economy," he said.
Minutes from the Fed's June meeting, released yesterday, showed some policymakers believe the Fed should stand ready to provide more support to the economy if the recovery flags, rekindling the threat of a debilitating downward spiral in prices and wages.
Others on the policy-setting Federal Open Market Committee, however, felt inflation risks might force the central bank to withdraw stimulus sooner than is currently anticipated.
Still, given the change in tune, some investors were betting the more dovish members of the committee would win the day in pushing for a third round of quantitative easing if the economy continues to deteriorate.
Mr Bernanke did not go into great detail regarding Europe, but the Fed chief's outlook on US growth prospects was understandably cautious.
After recovering from the steepest recession in generations beginning in the summer of 2009, the US economy has lost momentum in recent months. Gross domestic product expanded just 1.9 per cent in the first three months of the year, and the second quarter does not look to have been much better.
Mr Bernanke held to the view that recent weakness was due in part to temporary factors like energy costs and the effects on global industry from Japan's earthquake and tsunami.
But he acknowledged the labor market remains weaker than the Fed would like.
"The most recent data attest to the continuing weakness of the labor market," Mr Bernanke said.
Mr Bernanke defended the second round of bond buys against critics who said it had been ineffective.
He said the Fed estimates round two of quantitative easing, or QE2, lowered long-term interest rates by between 0.1 and 0.3 percentage point, which Mr Bernanke said would be roughly equivalent to a 0.40 to 1.20 percentage point decline in the federal funds rate, which is currently set in a range between zero and 0.25 per cent.
Regarding inflation, Mr Bernanke reiterated the recent rise in prices was mostly linked to transitory factors such as higher energy and commodity prices, and should trend back down.
Reuters