By Craig Torres and Scott Lanman

Nov. 8 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said the U.S. economy is likely to ``slow noticeably'' this quarter while high commodity prices and a weaker dollar may stoke inflation ``for a time.''

Bernanke said the Federal Open Market Committee, which sets the benchmark U.S. interest rate, saw risks to both growth and prices at its Oct. 31 meeting, when officials reduced the rate by a quarter-point to 4.5 percent. He added the Fed ``will be very dependent on the data'' and ``will respond as needed'' to keep growth and inflation stable.

``The committee expected that the growth of economic activity would slow noticeably in the fourth quarter,'' Bernanke said in testimony to the congressional Joint Economic Committee. While the FOMC anticipated growth to improve later next year, ``the committee also saw downside risks to this projection'' if the housing slump spilled into spending, he said.

The 53-year-old Fed chief is fighting on several fronts to maintain stable markets, keep the six-year economic expansion going and contain inflation expectations. Officials cut interest rates twice in the past two months, while signaling in the Oct. 31 statement they are reluctant to lower borrowing costs further.

``The Federal Reserve is stuck,'' said Allen Sinai, president of Decision Economics Inc. in New York. ``If the inflation risk wasn't there, then the prospects for the economy suggest much lower interest rates.''

Markets React

Treasury notes rose, stocks fell and the dollar dropped after Bernanke's remarks were released. The yield on the benchmark 10-year note was 4.28 percent at 12:10 p.m. in New York, down from 4.31 percent late yesterday. The Standard & Poor's 500 stock index fell 6.88, or 0.5 percent, to 1468.74. The dollar was at $1.4675 per euro, from $1.4637 yesterday.

The dollar fell even after Bernanke's counterpart, European Central Bank President Jean-Claude Trichet, said that ``brutal'' currency moves are never welcome. The dollar has fallen more than 4 percent against the currency shared by 13 European Union members in the past month, spurring U.S. export competitiveness while adding to price pressures.

The inflation outlook was ``subject to important upside risks'' from prices of crude oil and other commodities and the weaker dollar, Bernanke said. ``These factors were likely to increase overall inflation in the short run and, should inflation expectations become unmoored, had the potential to boost inflation in the longer run as well.''

First Since July

Bernanke's first full hearing on the economic outlook since July was marked by increased concern from lawmakers about the economy and criticism of the Fed's approach to the collapse in subprime mortgages, even as legislators praised the central bank for cutting interest rates.

Senator Charles Schumer, the New York Democrat who chairs the panel, criticized the Fed for not ``acting quickly or boldly enough'' to handle the risks in the housing and credit markets. Representative Jim Saxton of New Jersey, the committee's ranking Republican, noted that there are ``troubling indicators'' of economic performance as well as positive ones.

Mortgage defaults and delinquencies, which officials expect to worsen, continue to roil financial markets, causing investors to retreat from risk. Banks have tightened lending standards, which may pose a threat to spending.

`Resilient' Economy

Recent economic reports ``suggest the overall economy remained resilient in recent months,'' Bernanke said. ``However, financial market volatility and strains have persisted.''

Household spending is likely to grow more slowly as tighter credit, weaker home prices, and higher energy prices damp sentiment, he said.

``Most businesses appeared to enjoy relatively good access to credit, but heightened uncertainty about economic prospects could lead business spending to decelerate as well,'' he said.

While central bankers including Fed Governor Kevin Warsh and Philadelphia Fed President Charles Plosser reinforced the message this week that policy makers aren't yet prepared to cut rates further, traders have a different view. Federal funds futures contracts show the Fed is almost certain to lower the rate by another quarter point to 4.25 percent next month.

The FOMC cut the benchmark lending rate 0.75 percentage point to 4.5 percent in two meetings over the past eight weeks, the most aggressive easing since the economy was emerging from its last recession in 2001.

Cushion the Economy

Fed officials are trying to cushion the economy from eroding housing markets, without pushing interest rates to a level that would reignite inflation. Financial markets reflect both growth and inflation concerns.

Gold, a traditional hedge against rising consumer prices, rose to the highest level since 1980 yesterday. Crude oil prices posted record highs in New York trading this week. The dollar fell to an all-time low against the euro yesterday.

Wall Street firms have already written down billions of dollars of mortgage-related assets. Credit-risk measures continue to widen as analysts forecast more banks will write off nonperforming loans and debt backed by home loans to borrowers with low credit scores. Subprime loan delinquencies rose to 15 percent in the second quarter.

Bernanke suggested he is monitoring the risk that rising home foreclosures will slow economic growth as almost 450,000 subprime mortgages per quarter see higher interest rates through the end of next year.

``A sharp increase in foreclosed properties for sale could also weaken the already struggling housing market and thus, potentially, the broader economy,'' Bernanke said.

Growth Picture

The economy shook off the housing slump and accelerated to an annual pace of 3.9 percent in the third quarter, the fastest in more than a year. Payrolls rose by 166,000 jobs in October and 96,000 in September. Still, Fed officials said in their statement that ``the pace of economic expansion will likely slow'' as the housing downturn deepens.

In speeches and interviews this week, Fed officials said they expect the economy to expand about 2 percent or less in the fourth quarter. Plosser told the New York Times this week that growth would have to drop below 1 percent to 1.5 percent to justify supporting another rate cut.

The central bank's preferred inflation benchmark, the personal consumption expenditures price index, minus food and energy, rose at an annual rate of less than 2 percent every month since June.

Home Prices

Sales of previously owned homes fell in September to the lowest level since National Association of Realtors began keeping records in 1999. Median prices fell 4.2 percent from the same month a year earlier. The number of homes for sale at month end rose to 4.4 million, representing a record 10.5 months' supply.

The Fed chief said the central bank doesn't take ``an alarmist'' view of the impact that lower property values may have on consumer spending.

Bernanke told lawmakers the Fed is ``on schedule'' to deliver tighter restrictions on mortgage lending practices by year-end. Fed officials are looking at four areas: low documentation loans, the exclusion of taxes and insurance from subprime loan payments, prepayment penalties, and standards to judge a loan's affordability.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net

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