Bernanke: Fed ready to act if economy worsens (AP)

WASHINGTON – Federal Reserve Chairman Ben Bernanke told lawmakers Wednesday the Fed is ready to act if the economy gets weaker. He warned them that allowing the nation to default on its debt would send "shock waves through the entire financial system."

Underscoring how fragile the economy remains two years after the Great Recession, Bernanke laid out three new steps the Fed could take, including a fresh round of government bond purchases designed to stimulate economic growth.

"We have to keep all the options on the table. We don't know where the economy is going to go," Bernanke told the House Financial Services Committee.

The Fed chairman stopped short of promising anything, but Wall Street appeared comforted that the central bank was poised to act. The Dow Jones industrial average was up more than 150 points during his testimony to Congress, and closed up 45.

The nation was creating about 200,000 jobs a month this spring. But hiring slowed almost to a standstill in June, with 18,000 new jobs. It takes about 125,000 a month just to keep up with population growth.

While Bernanke made his twice-yearly appearance before Congress, lawmakers and the White House were trying to salvage talks on how to reduce the federal deficit and whether to raise the limit on what the government can borrow.

If they fail to strike a deal on the debt limit by Aug. 2, the White House has said, the nation will default. President Barack Obama has said he cannot guarantee even that Social Security checks would go out the next day.

Moody's Investors Service threatened Wednesday to lower the United States' credit rating, saying there is a small but rising risk of default. Economists have warned that the credit system would tighten, not unlike the worst days of the 2008 financial crisis. Before Congress, Bernanke added his own dire predictions.

"If we went so far as to default on the debt, it would be a major crisis because the Treasury security is viewed as the safest and most liquid security in the world," he said.

"It's the foundation for most of our financial — for much of our financial system," he added. "And the notion that it would become suddenly unreliable and illiquid would throw shock waves through the entire global financial system."

Asked whether interest rates would go up for everyday Americans, Bernanke said: "Absolutely."

The Fed bought $600 billion in government bonds late last year and early this year, a program designed to keep interest rates low and support the prices of assets such as stocks.

It was the second time the Fed had taken that step since the recession started. It was known on Wall Street as "QE2," or a second round of "quantitative easing." Besides a third round, Bernanke laid out two additional options if the economy gets weaker:

• The Fed could offer financial markets more clarity about how long it tends to leave interest rates at record lows, where they have stood since December 2008. For now, the Fed says only that rates will remain "exceptionally low" for an "extended period."

• It could start paying banks less interest on the excess money they park with the Fed. It doesn't pay much now — 0.25 percent. But paying even less would encourage the banks to loan the money out rather than sending it to the central bank.

Bernanke said the measures would be necessary only if deflation, a cycle of falling prices that damages the economy, became a threat. For now, prices are still rising. Some inflation is healthy, economists say.

Critics of the Fed's two previous rounds of "quantitative easing" have said the real threat is the opposite — that the central bank will create runaway inflation by flooding the economy with money.

Bernanke said the Fed was ready to raise interest rates if inflation becomes a serious threat.

The Fed has said that temporary factors, such as high gas prices and manufacturing disruptions caused by the earthquake and tsunami in Japan, are partly to blame for the economy's sudden sluggishness.

Bernanke told Congress that the Fed believes those impediments should ease in the second half of the year.

Laying out the three options was "a very generic statement, rather than a specific commitment to doing this," said Michael Hanson, senior economist at Bank of America. He said Bernanke was trying to "comfort people that the Fed is ready to act if needed."

Paul Ashworth, chief U.S. economist at Capital Economics, said any decision on Fed action probably wouldn't happen until next year.

The last time the Fed bought up Treasury bonds, Bernanke laid out the plans in a speech Aug. 27, 2010. The Dow stood at about 10,000 at the time and rallied to higher than 12,800 this spring before pulling back. It closed Wednesday at 12,491.

"The market's reaction reflects Bernanke's message that either the economy will reaccelerate or the Fed will step in again," said Jim O'Sullivan, chief economist at MF Global, a brokerage.

At least at first, the market appeared to treat Bernanke's comments before Congress as a similar moment to his August 2010 speech, delivered in Jackson Hole, Wyo., said Joe Saluzzi, co-head of equity trading at Themis Trading in Chatham, N.J.

"It's just silliness, in my opinion," he said. "There's nothing new here. But the bulls are taking this as, `This is fantastic.'"

___

AP Economics Writer Christopher S. Rugaber in Washington and AP Business Writers Matthew Craft and David K. Randall in New York contributed to this report.

Bernanke "prepared to respond" if economy worsens (Reuters)

WASHINGTON (Reuters) – The Federal Reserve is ready to ease monetary policy further if economic growth and inflation slow much more, Chairman Ben Bernanke said on Wednesday, 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 re-emerge, implying a need for additional policy support," Bernanke told the House of Representatives Financial Services Committee.

The Fed launched an unprecedented round of bond-buying in late 2009 to try to boost the economy and make credit more available, spending some $1.7 trillion on mortgage-backed securities and Treasuries before it ended in March 2010. Later in the year it initiated a second round that wrapped up in June this year in which $600 billion of bonds were bought.

Still, the economy remains in a soft recovery.

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 percent.

Hopes for further monetary support sent U.S. stocks, which have taken a drubbing over the last week on worries about Europe's debt troubles and a soft U.S. economy, 1 percent higher, while Treasury bond prices and the dollar tumbled.

"The market wasn't thinking there would be any mention of QE3 whatsoever and here we're finding out QE3 is not being ruled out. It's a tantalizing headline," said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi.

Asked whether the Fed would be willing to launch another bond purchase program if the economy slumps, 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 program, which ended in June, raised eyebrows both at home and abroad when it was first announced back in November.

At least one Fed official, Dallas Fed Bank President Richard Fisher, on Wednesday served noticed that he would oppose any such idea because, he said, the economy already has ample liquidity and adding more might not spur activity.

"I will not support further monetary accommodation," Fisher told reporters after a speech in Dallas. "There's so much liquidity out there, what's the trigger to put it to work?" said Fisher, a voter on the U.S. central bank's policy-setting committee.

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, Bernanke reiterated his warning that a failure to raise the debt ceiling would deal a severe blow to the global economic recovery.

"Cutting programs 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 on Tuesday, 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.

DOOR OPEN TO QE3

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.

"My initial reaction was 'QE3 here we come'," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "We suspected the Fed would come up with some sort of QE3 in light of the disturbance surrounding the sovereign debt markets."

Bernanke did not go into great detail regarding Europe, but the Fed chief's outlook on U.S. growth prospects was understandably cautious.

After recovering from the steepest recession in generations beginning in the summer of 2009, the U.S. economy has lost momentum in recent months. Gross domestic product expanded just 1.9 percent in the first three months of the year, and the second quarter does not look to have been much better.

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," Bernanke said.

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 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 percent.

Regarding inflation, 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.

IEA releases oil reserves to prop up economy (Reuters)

PARIS (Reuters) – Oil consumer nations on Thursday announced a surprise release from strategic government petroleum stockpiles in a bid to push down fuel prices and underpin the global economy.

The 28-member International Energy Agency said it would release 60 million barrels a day over an initial 30 days to fill the gap left by the disruption to Libya's output.

The United States will provide half the volumes from its huge 727-million barrel crude reserve, about 1.5 days of U.S. consumption, with Europe supplying 30 pct in crude and refined products and the rest from Pacific OECD nations.

The release, only the third in the IEA's 37-year history, is a blow for the Organization of the Petroleum Exporting Countries and in particular for its biggest producer, Saudi Arabia, a close U.S. ally.

Despite Saudi efforts, the producer cartel failed to raise output at a meeting on June 8 leaving Riyadh to pump more unilaterally.

Before the OPEC meeting Riyadh had discussed a crude swap with the United States that would have seen U.S. reserves supplied to Europe, but failed to reach agreement.

"The move is significant as it represents a reach by member countries for the remedy of last resort to high prices," said U.S. energy analyst John Kilduff at Again Capital.

"Clearly the energy price spike is being cited as the reason for the economic slowdown and this is reaction to that. The Libyan outage provides good cover."

OPEC member Libya was exporting about 1.2 million bpd before the rebellion that brought its oil industry to a standstill.

"This supply disruption has been underway for some time and its effect has become more pronounced as it has continued," said the IEA. Libya was likely to remain off the market for the rest of 2011, it said.

"Greater tightness in the oil market threatens to undermine the fragile global economic recovery," the IEA said.

PRICE IMPACT UNCERTAIN

Oil prices traded $7.07 a barrel lower for benchmark Brent crude at $107.14 and U.S. crude fell $4.68 a barrel to $91.73 a barrel.

With world oil stocks at comfortably high levels by historical standards, oil analysts were divided on whether prices would fall further or not.

"I think the IEA is trying to act like a central bank," said Dominick Chirichella at New York's Energy Management Institute. "I don't think anyone will be comfortable being long oil ... We may see (U.S.) oil trading in the $80s very soon."

But Carl Larry at Blue Ocean brokerage in New York said prices might not have much further to fall.

"This is an economic stimulus ... in oil dollars," said Larry. "On the other hand I think we have confirmed the bottom of the oil market here at $109 for Brent and $90 for WTI."

DEPARTURE FOR IEA

The decision appears to represent a departure for the IEA from previous emergency releases and will not go down well with OPEC.

In the 1990-1991 Gulf conflict when Iraq invaded Kuwait much larger volumes of crude were shut. When Hurricane Katrina in 2005 hit U.S. refineries the IEA release consisted mostly of European refined products to the United States.

"There is no reason to do this," said a senior Gulf Arab OPEC delegate.

"The market is not short of supply. Kuwait and the Saudi Arabia have been raising production but there have not been many buyers. The IEA is just playing politics with the U.S."

Leading U.S. oil companies appeared to share that view.

The American Petroleum Institute which represents Exxon and Chevron among others said the plan was "ill timed" and "makes little sense" because there was no supply emergency.

IEA Executive Director Nobuo Tanaka said the action was intended to work in tandem with Saudi Arabia and other Gulf Arab producers.

"Our stocks release is intended to complement the action of those key producers to fill the gap. Together producer and consumers will have taken concrete steps," Tanaka said.

The agency will review the need for a further release in a month.

"The IEA will continue to watch further developments and we will use the next 30 days to reassess the situation," said Tanaka.

(additional reporting by Amena Bakr, Alex Lawler, Barbara Lewis, Salem Gebrekidan, Antonita Devotta, Timothy Gardner and Ayesha Rascoe, writing by Richard Mably)