All eyes on Bernanke as recession looms

Tuesday, 23 August 2011 00:02 - - {{hitsCtrl.values.hits}}

WASHINGTON (Reuters) - With the global economy sputtering and financial markets on the rocks, the world needs reassurance the U.S. central bank stands ready to save the day.

Federal Reserve Chairman Ben Bernanke will make a speech on Friday at a lodge in Wyoming’s Jackson Hole, where policymakers and academics meet once a year to talk shop.

Last year, Bernanke used the podium to suggest the Fed could help growth by buying long-term bonds, a prelude to a program enacted soon afterward that did just that.

However, no grand new plan is expected to be hatched at this year’s meeting.

In part that’s because the Fed already unveiled a new policy tool this month when it pledged to keep interest rates near zero into 2013.

Central banks rarely make such promises, so consider that a big move.

But the world grows more nervous every day that a new recession lurks around the corner. Economists see rising risks that U.S. growth could evaporate, while Europe languishes in a debt crisis. Even strong performers like China and Brazil show signs of slowing.

Moreover, stocks have plunged, further threatening the economy because consumers could pull back if they sense their retirement savings are dwindling.

So at the very least, Bernanke will be expected to hold our hands a little when he speaks.

“Markets are increasingly hoping there will be some signs that the Fed will coming running to the rescue,” said Paul Dales, an economist at Capital Economics in Toronto.

Most economists expect Bernanke will explain what’s in his policy toolbox while promising to use those tools if necessary.

Markets will hush when he begins his speech, and he will be mindful not to disappoint.

One danger looming over the world economy -- and which could goad Bernanke into more action -- is the prospect that the European crisis could worsen.

Investors are nervous that some countries might not pay back their debts, so they are demanding some European governments pay higher interest rates to borrow.

Ireland, Portugal and Greece currently cannot borrow on the market, and now market forces appear to be tilting against larger countries, threatening to create a much larger crisis.

Policymakers are scrambling to contain this, with the European Central Bank buying Italian and Spanish bonds this month.

But the ECB is internally divided over that move, creating further anxiety for investors. On Monday, the central bank will release figures that could show how committed it is to propping up Italy and Spain.

A bad reaction by investors to that data -- or to revised readings due during the week on U.S. and British second-quarter economic performance -- could increase pressure on Bernanke to act.

Indeed, many people in the market expect the Fed will eventually launch QE3, the name given to what would be the third installment of a program to help the economy by buying assets on the market.

“Expectations are for more to happen. It’s just a question of exact timing of when it happens,” said Goldman Sachs economist Andrew Tilton in New York.

When Bernanke takes the podium, his speech will be measured against that expectation.