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The U.S. economy has performed "reasonably well" over the past six months, Fed Chairman Ben Bernanke said Thursday in Congress, however, "the economic outlook has been importantly affected by recent developments in financial markets, which have come under significant pressure in the past few months." Testifying before the Joint Economic Committee, Bernanke said mortgage delinquencies are likely to rise further in coming months. Concerns over mortgage-backed securities have greatly reduced investors' appetite for asset-backed commercial paper. Also contributing to recent credit-market crisis, Bernanke said, was investors' reluctance to fund LBOs and buy speculative-grade corporate bonds. Banks, concerned about "difficult-to-predict draws on their liquidity" have become less willing to lend to customers and each other, the sum of which could restrain economic growth as borrowing costs rise, he said.

Despite Q3's surprisingly robust 3.9% GDP growth, Bernanke said the Fed doesn't expect recent growth performance to be sustained. Reduced mortgage availability will continue to stress housing-related activity, and household spending is slowing. The Fed foresees a noticeable slowing of economic growth in Q4 and during the first part of 2008. Bernanke said he sees important upside inflation risks -- higher oil and commodity prices and a weak U.S. dollar. Still the Fed expects inflation to stay in a "range consistent with price stability next year" as inflation expectations appear "reasonably" anchored, but that could change should price expectations "become unmoored." The Chairman suggested lenders "work with borrowers" to reduce mortgage foreclosures, but added regulators must insure workouts "protect consumers and do not disguise lenders' losses." Bernanke reiterated his plan to propose rules that govern how lenders issue subprime loans.

"Bernanke is in a box and it is getting smaller," FTN Financial's Christopher Low remarked.

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Source: Bernanke: Economic Growth Won't Last