The U.S. Federal Reserve Board still expects the U.S. economy to halt its descent, and start to rebound, later this year, says Ben Bernanke, Fed chairman.

The Fed already sees signs that the decline is slowing, but the economy remains vulnerable to financial market instability and labour market weakness.

Speaking to the Joint Economic Committee in Washington, D.C., Tuesday, Bernanke said, “We continue to expect economic activity to bottom out, then to turn up later this year.” This forecast is based on the Fed’s view that the housing market is beginning to stabilize and that the sharp inventory liquidation that has prevailed will slow over the next few quarters. Final demand should also be supported by fiscal and monetary stimulus, he added.

“An important caveat is that our forecast assumes continuing gradual repair of the financial system; a relapse in financial conditions would be a significant drag on economic activity and could cause the incipient recovery to stall,” he cautioned.

Moreover, Bernanke said that even after a recovery gets under way, “the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further. We expect that the recovery will only gradually gain momentum and that economic slack will diminish slowly. In particular, businesses are likely to be cautious about hiring, implying that the unemployment rate could remain high for a time, even after economic growth resumes.”

Given that view, Bernanke said that the Fed expects inflation will remain low. “Indeed, given the sizable margin of slack in resource utilization and diminished cost pressures from oil and other commodities, inflation is likely to move down some over the next year relative to its pace in 2008,” he explained.

The current signs of a slower fall are being led by consumers. Bernanke noted that consumer spending actually grew in the first quarter, and that spending power should be bolstered by the government’s fiscal stimulus program. There are also signs that the housing market is bottoming, he said.

However, the weak labour market and negative wealth effects are likely to weigh on households in the months ahead. And, compared with the consumer side, business investment remains extremely weak and conditions in the commercial real estate sector are poor, he noted.

The outlook for economic activity abroad is also an important consideration, the Fed chief stressed. On that front, he said that, “a few indicators suggest, again quite tentatively, that the decline in foreign economic activity may also be moderating. And, as has been the case in the United States, investor sentiment and the functioning of financial markets abroad have improved somewhat.”

“Conditions in a number of financial markets have improved in recent weeks, reflecting in part the somewhat more encouraging economic data. However, financial markets and financial institutions remain under considerable stress, and cumulative declines in asset prices, tight credit conditions, and high levels of risk aversion continue to weigh on the economy,” he added.

IE