Bernanke says U.S. economy faces big threat

By Pedro Nicolaci da Costa

NEW YORK (Reuters) - Federal Reserve Chairman Ben Bernanke on Wednesday gave a dour assessment of the U.S. economy, emphasizing a "significant threat" from turmoil in credit markets in remarks that suggested more interest-rate cuts could be coming.

Bernanke said it will take some time to restore normal credit flows and pledged the U.S. central bank would continue to act aggressively to fight the crisis. Importantly, he said inflation risks were ebbing, which suggests Fed officials see latitude to lower borrowing costs further.

"By restricting flows of credit to households, businesses, and state and local governments, the turmoil in financial markets and the funding pressures on financial firms pose a significant threat to economic growth," Bernanke told the Economic Club of New York.

"We will continue to use all the tools at our disposal to improve market functioning and liquidity," he said, adding that policy-makers' aggressive and quick response crucially distinguished this episode from the crisis of the 1930s.

Another senior Fed official, Vice Chairman Donald Kohn, echoed Bernanke's downbeat view of the growth outlook and his qualified relief on prices, saying inflation seems "likely to move onto a downward track."

Kohn further said that any effect last week's emergency interest rate cut may have had on easing credit was "overwhelmed" by escalating mistrust among financial institutions unwilling to lend to one another.

U.S. stocks, already down sharply on Wednesday on news of an unexpectedly big drop in September retail sales and weak factory data, sold off even more after Bernanke's remarks and finished the day with their largest percentage losses since the 1987 crash.

St. Louis Federal Reserve Bank President James Bullard said the sharp 1.2 percent drop in retail sales increased the risk of recession. "The third quarter, I think, will be flat to slightly negative," he told reporters in Little Rock, Arkansas. "That is going to push up the probability that it will later be named a recession."