Connect to share and comment

Bernanke warns against premature policy tightening


US Federal Reserve Chairman Ben Bernanke warned Wednesday that tightening monetary policy now could stall the US recovery, but added that another few months of positive data could lead the Fed to start reining in stimulus.

Defending the Fed's continuing stimulus, Bernanke told Congress that US economic growth continues at a moderate pace with no threat of inflation or, as some analysts have worried recently, deflation.

On the other hand, he stressed that still-high joblessness and the drag on growth of federal spending cuts continue to justify the Fed's aggressive bond-purchase policy aimed at keeping longer-term interest rates low.

Bernanke told Congress's Joint Economic Committee that the Fed's policy board, the Federal Open Market Committee, could decide to begin reducing the bond purchases in its next few meetings, but only if the FOMC has confidence that economic gains can be sustained.

"A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further," Bernanke said in a statement.

The FOMC, he said, is well aware of the costs and risks to having held interest rates at an ultra-low 0-0.25 percent since the end of 2008.

But the Fed needs to stick to its mission of helping drive down unemployment as long as inflation is not a threat, Bernanke emphasized.

His testimony sparked a surge in European and US share markets and in the euro, with most of the gains given back in subsequent trade amid debate over the emphasis in Bernanke's message.

But analysts said it was clear: the Fed's $85 billion a month bond purchases known as quantitative easing will only be cut back when the economy shows better signs of sustainable growth.

"He continues to recognize fiscal policy as a threat to growth, not just in the four months of the year already behind us but in the months ahead. And, he believes the job market is weak," said Chris Low of FTN Financial

At the same time, "It's important to realize the Fed has faith its policies will work, which means they believe the economy will respond positively and tapering will eventually be necessary."

The S&P 500 gained around one percent after his statement was released, but later closed down 0.8 percent. At 2000 GMT the euro was down 0.4 percent on the dollar, to $1.2855.

Bernanke told legislators that the job market has shown improvement recently, with average monthly job generation at more than 200,000 over the past half-year, pushing the jobless rate down to 7.5 percent.

But he said the rate of long-term unemployment is still high and that eight million people are still working part-time when they want full-time jobs.

He also said that even as the economy expanded at a 2.5 percent pace in the first quarter, sharp US government budget cuts that started in March and the rise in payroll and other taxes from January will exert "a substantial drag on the economy this year."

His testimony came amid much speculation over when the Fed will begin slowing QE bond purchases, its tool for stimulating the economy.

Queried on this by the legislators, Bernanke said the FOMC is preparing an exit strategy and that they were "certainly confident" that they could rein in the program without hurting economic stability.

However, he said, when and how it does all depends on the flow of the economic data.

"What we are looking for is increased confidence that the labor market is improving," he said.

FOMC vice chairman William Dudley told Bloomberg television in an interview aired Wednesday morning that the board probably needed to see three to four months more of data to understand the economy's direction in the light of the government's "sequester" spending cuts.

"I don't really understand very well how the tug-of-war between the fiscal drag and the improving economy are going to work their way out," Dudley said.

Minutes from the FOMC's last meeting three weeks ago that were released Wednesday supported the hesitancy.

They made clear that the Fed was preparing an exit strategy, but that members remained divided over the urgency of taking action while economic indicators showed the economy was still not strong enough.