Bernanke clears way for Fed rate cut so. The dollar goes down again?

Ben Bernanke put the Federal Reserve on a path towards a December rate cut in a speech on Thursday night in which he said the relapse in financial markets had resulted in a “tightening in financial conditions” that had the potential to harm the real economy.

The Fed chairman also said recent data on household spending had been “on the soft side” and warned that the combination of higher petrol prices, the weak housing market, tighter credit conditions and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead.

Mr Bernanke’s comments complete the repositioning of the US central bank begun a day earlier by his deputy, Don Kohn. Prior to that, hawkish comments by less-senior Fed officials had fuelled tension with the bond market, which was pricing in more rate cuts.

Mr Bernanke said the Fed remains concerned about the risk to inflation from rising food, energy and import prices. In an apparent warning to investors that a Fed rate cut on December 11 is not guaranteed, he said there was a lot of information still to come, including an important labour market report.

But the thrust of his speech was that the Fed would cut rates providing three conditions are met: financial markets remain distressed, the risks to inflation do not increase and the remaining economic data do not come in stronger than expected.

His comments came as new revised figures showed the US economy grew at its fastest rate in four years in the third quarter. An export surge fuelled by a weaker dollar and global growth more than offset the impact of the deepening slump in housing.

Gross domestic product grew at 4.9 per cent in the quarter, almost twice the Federal Reserve’s estimate of the maximum sustainable rate for the US economy.

However, a sharp rise in inventories reinforced fears of weak fourth-quarter growth.

US Treasury bond yields fell sharply amid increased expectations of interest rate cuts. The yield on the 10-year note fell 10bp to 3.94 per cent and on the two-year note 10.6bp to 3.04 per cent.

Equity markets were volatile as the S&P 500 erased early gains to end fractionally up by 0.05 per cent. Prior to Mr Bernanke’s speech, futures markets were already pricing in a 25bp rate cut at the Fed’s meeting in December. The chance of a 50bp cut to 4 per cent was priced at 60 per cent, up from 47 per cent.

Meanwhile, the White House released a bullish new set of economic forecasts, predicting the economy would grow at 2.7 per cent next year.

The upward revision to growth came as fresh data on new home sales and house prices delivered yet more gloom.

Torsten Slock, an economist at Deutsche Bank, said: “There are three sharks stalking the economy, the oil shark, the credit shark and the housing shark.”