A "substantial correction" is under way in the US housing market but it has not so far had a big effect on the rest of the economy, Ben Bernanke, the chairman of the Federal Reserve, said on Wednesday.
The Fed chairman told the Economic Club of Washington that the decline in residential construction was a "major drag" on economic growth and would subtract "about one percentage point" from growth in the second half of this year and "probably something going into next year as well".
However, he said that up to this point non-housing related sectors remained relatively strong.
Mr Bernanke also reiterated his concern about inflation, saying that while the Fed expected inflation to come down gradually, "it is something that we have to watch very carefully to make sure that it does not rise or even remain where it is".
Taken together, the remarks will strengthen expectations of an extended interest rate pause, while the Fed continues to evaluate incoming growth and price data.
On housing, Mr Bernanke said the key questions for the Fed were "how far will this correction go?" and to what extent would it "spill over" into the broader economy? He said it was very difficult to predict when the housing market would stabilise, because people bought houses both to live in and as investments.
"Right now we have people very unsure about the progress of prices," he said. But he said there were "strong fundamentals" underpinning the market, including low unemployment, rising wages and demographic shifts.
Mr Bernanke said the Fed would watch carefully to see how the slump in housing construction and stalling in house prices affected consumer behaviour.
Meanwhile Robert Rubin, the former US Treasury secretary, told the Financial Times that the record high for the Dow Jones industrial index should not be taken as proof that the economy was on the right track.
"Markets have historically been very poor predictors in many cases," he said. "We all remember the Dow hit a high before October 18 1987, then the market was down 22 per cent in one day."
Mr Bernanke's comments on housing followed his first speech in more than a month, which made no direct reference to current economic conditions.
Instead, he called for a national effort to increase US savings to minimise the burden of an ageing population on future generations. Describing the current level of household saving as "exceptionally low", he said "a broad-based increase in household saving would benefit both the economy and the millions of American families who currently hold very little wealth".
Noting that it was difficult to promote household saving, the Fed chairman urged the administration and Congress to "reduce the government's current and projected budget deficits" in order to boost overall national savings.
Mr Bernanke declared "reform of our unsustainable entitlement programmes should also be a priority", and called for reforms to remove obstacles to older people remaining in the workforce past traditional retirement ages.
Earlier Tim Geithner, the president of the New York Fed, painted an upbeat picture of emerging market fundamentals in a separate speech in Washington. He said that reductions in balance-sheet exposure to currency risk, a shift to longer- term debt and greater scope for fiscal and monetary policy to respond to shocks meant "that future sudden changes in financial flows should not precipitate the damaging runs on the financial assets of a country that they have in the past".
Source: Financial Times