Fed will act as needed to support growth: Bernanke

By Mark Felsenthal

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke on Thursday held the door open to more interest rate cuts to help the struggling U.S. economy, but told Congress the central bank expects growth to pick up later in the year.

The Fed "will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks," Bernanke told the Senate Banking Committee.

He acknowledged the outlook for the economy had worsened in recent months and said risks to growth had picked up. His comments reinforced investors' expectations the central bank would lower interest rates by a half-percentage point at its next meeting on March 18.

However, the central bank chairman also said he expects sluggish growth to give way to a somewhat stronger expansion in the second half of the year as the impact of fiscal and monetary stimulus now put in place is felt.

"Our policy stance must be determined in light of the medium-term forecast for real activity and inflation, as well as the risks to that forecast," he said.

The Fed has already lowered benchmark borrowing costs by 2.25 percentage points since mid-September, taking the overnight federal funds rate down to 3 percent.

Bernanke painted a somber picture of risks facing the economy, and stock prices and the dollar fell on his gloomy assessment. The Dow Jones industrial average ended down more than 175 points, or 1.4 percent on the day.

U.S. short-term interest rate futures prices implied about a 20 percent chance the central bank will drop rates by three-quarters of a percentage point in March after Bernanke's testimony, up from as low as the 6 percent implied expectation earlier. A half-point cut is fully priced in.

CONCERNED ON GROWTH AND INFLATION

Bernanke told lawmakers the Fed will lower its projections for U.S. growth in forecasts to be released next week, bringing them closer into line with views in the private sector. In November, it had said the economy would likely expand 1.8 percent to 2.5 percent this year.

The Fed chairman forecast a further drop in home building and related activities, and said a softer jobs market, higher energy prices and falling home values could be expected to weigh on consumer spending in the near term.

Tighter credit is also likely to continue to hold growth back, he said.

"A significant worsening in financial conditions or in credit availability would certainly be a warning bell that we need to take further actions," Bernanke said.

However, the latest comments from Bernanke reflected a slightly softer tone than remarks a month ago, when he said the Fed stood ready to take "substantive additional action" -- a signal of the sharp rate cuts that followed late in the month.

His remarks "suggest that markets should not assume that sizable moves are in prospect," economists at Goldman Sachs said in a note to clients.