Fed chief expects economy to slow

Interest rates not likely to fall soon

WASHINGTON -- The U.S. economy will slow over the remaining months of this year, Federal Reserve Chairman Ben Bernanke said Wednesday.

The Fed chief said a significant deterioration in the subprime mortgage market, a slowdown in residential construction and tighter credit standards for consumers and business will cause the slowing.

Improvements in inflation might be only temporary, Bernanke said, signaling that he doesn't favor lowering interest rates anytime soon. His comments came in his semi-annual report on monetary policy to the House Financial Services Committee.

Fed economists, he testified, lowered their growth forecast for 2007 by a quarter of a percentage point. The Fed in February forecast a growth rate of as much as 3 percent this year, but now expects growth of 2.5 percent to 2.75 percent.

Bernanke's testimony underscored the housing sector's continued drag on the U.S. economy. The Fed chief said "conditions in the subprime mortgage sector have deteriorated significantly, reflecting mounting delinquency rates on adjustable-rate loans," which are at record levels.

And, he said, problems in the subprime market -- which involves home loans to borrowers with weak or limited credit histories -- are spreading to other financial instruments.

"Credit spreads on lower-quality corporate debt have widened somewhat, and terms for some leveraged business loans have tightened," he said. Translation: Businesses with shakier balance sheets are finding it harder to get loans, and banks are less willing to lend for buyouts of companies if the deal involves issuing a lot of debt.

But these widening credit spreads -- the difference in yields between financial instruments -- remain near the low end of the historical range, Bernanke cautioned, adding that bond and business loan markets remain brisk.

However, investment bank Bear Stearns confirmed Tuesday night that two of its hedge funds for rich investors, which held investments above $20 billion, have effectively gone broke because of exposure to subprime loans that were bundled and sold in the secondary mortgage market. That is raising fears that such problems may spread further in financial markets.

The Fed chairman devoted much of his testimony to what the Fed is doing to strengthen supervision of mortgage and home-equity lending. He expects to implement rules that would combat unfair and deceptive advertising in mortgage and home equity lending this year.

Bernanke acknowledged that he is considering supporting the idea of federally licensing mortgage brokers, whom Congress has blamed for many of the abuses and problems in the subprime mortgage market.

Economic growth next year is expected to remain at 2.5 percent to 2.75 percent, he said, while unemployment is expected to remain low at 4.75 percent, though that's slightly higher than this year.

"It struck me as a little cautious. I think the economy is going to be a little stronger than Bernanke indicated, but it's his job to be cautious," said Mark Vitner, senior economist for Wachovia.

Bernanke signaled that he does not expect the Fed's rate-setting body to move its benchmark federal funds rate anytime soon. The rate has been at 5.25 percent since June 2006. The federal funds rate is the overnight rate that banks charge one another. It influences everything from mortgage rates to interest on credit card debt.