Market turmoil ‘will hit economy’

By Eoin Callan in Washington

Financial Times

Turmoil in financial markets is likely to intensify the downturn in the US housing market and could hit consumer spending, according to San Francisco Federal Reserve Bank President Janet Yellen.

“A drop in house prices is likely to restrain consumer spending to some extent,” Ms Yellen said in a speech, adding that “should the decline in house prices occur in the context of rising unemployment, the risks could be significant.”

The comments from the influential policymaker underline growing fears that the US economy will be impaired by the decline in the housing market and tightening lending conditions.

Ms Yellen stressed that she was speaking only on behalf of herself and is not a voting member of the central bank’s rate-setting Federal Open Market Committee in 2007.

The regional Fed president also warned that world economic growth was likely to slow and that US export growth was likely to evaporate, in a further blow to the American economy.

The outlook for global growth and the impact of market turmoil are expected to be the focus of a trip by Hank Paulson, US Treasury Secretary, to London and Paris next week.

Mr Paulson will on Monday morning meet French President Nicolas Sarkozy and his finance minister, Christine Lagarde, before travelling to London to meet Prime Minister Gordon Brown and Chancellor Alistair Darling.

Ms Yellen said that she had expected global growth to slow and export growth to moderate before the credit crunch, adding that the risks of a sharper downturn had now increased.

The bank president said recent data showed “most measures of house prices at the national level fell moderately”, adding that “financial market turmoil seems likely to intensify the downturn in housing”.

She also warned that there could be “other negative impacts on consumer spending” from tightening lending conditions.

“Credit-constrained consumers with adjustable-rate mortgages seem likely to curtail spending as interest rates reset at higher levels and they find themselves with less disposable income,” she said.

She added that “reduced availability of high loan-to-value ratio and piggyback loans may drive some would-be homeowners to pull back on consumption in order to save for a sizable downpayment”.

But she was more upbeat about business resilience, saying that “despite the hike in borrowing costs for higher-risk corporate borrowers and the illiquidity in markets” that financing remained “readily available” for corporate investment.

Yet she added that “the outlook for capital spending could worsen if business confidence were shaken by turbulence in global financial markets”.

Governor Frederic Mishkin, a voting member of the FOMC was due to speak later on Monday.