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Saturday, September 01, 2007

Bernanke fuels hope of interest rate cuts

Bernanke fuels hope of interest rate cuts
By Krishna Guha in Jackson Hole and Andrew Ward in Washington
Copyright The Financial Times Limited 2007
Published: August 31 2007 15:10 | Last updated: September 1 2007 00:35

Ben Bernanke said on Friday the Federal Reserve would act as needed to ease the impact of recent market turmoil on the economy, in a speech widely interpreted as opening the door to possible interest rate cuts.

Most analysts viewed the remarks as a sign that the Fed is virtually certain to lower rates at its September 18 policy meeting, although the Fed chairman, who said the effects of market turmoil remained uncertain, did not make any commitment to do so.

In his most detailed remarks on the liquidity crisis since it began to intensify some three weeks ago, Mr Bernanke made it clear the central bank would not cut rates merely to bail out investors. He said: “It is not the responsibility of the Federal Reserve – nor would it be appropriate – to protect lenders and investors from the consequences of their financial decisions.”

But he added that developments in financial markets “can have broad economic effects felt by many outside the markets”.

The Fed would “act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in markets”, Mr Bernanke told central bankers at their annual retreat in Jackson Hole, Wyoming.

Mr Bernanke’s remarks came as President George W. Bush announced measures to help struggling homeowners refinance mortgages through an expansion of the Federal Housing Administration and tax changes.

But Mr Bush insisted there would be no government bail-out to solve the subprime mortgage crisis.

Investors were cheered by the two speeches, with the S&P 500 index closing up 1.1 per cent to 1,473.99.

A key measure of the cost of insuring against defaults on the credit markets cheapened significantly, in a sign that confidence may be returning. The CDX index of credit derivatives moved to 69.5 basis points, down from 73bp on Thursday.

But banks still faced higher financing costs in the money markets, as the key three-month Libor rate reached a new high of 5.62125 per cent – its highest level since the beginning of the credit crunch and its highest since 2001.

Meanwhile, investors’ flight to the relative safety of Treasury bonds appeared to have abated, with the yield on the two-year bond rising 4bp to 4.15 per cent.

Many in the market who had been pricing in a cut in interest rates were buoyed by the fact that Mr Bernanke gave no hint that he would not do so. “It was his duty today to dissuade the markets if he felt the markets were incorrect in their assumptions,” said Tony Crescenzi, strategist at Miller Tabak.

Mr Bernanke said recent data suggested the economy grew at a “moderate pace” this summer, but they may not be a good guide to how the economy will perform as the effects of the financial turmoil bite.


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