Federal Reserve Chairman Ben Bernanke on Wednesday offered a tempered view of the U.S. economy, pouring cold water on the notion recent upbeat signs herald a stronger recovery.
Bernanke told Congress that unless growth accelerated, the unacceptably high U.S. unemployment rate would not keep dropping.
But he stopped short of signaling further Fed bond purchases, dashing the hopes of some traders in financial markets who were betting on more monetary stimulus.
The job market is far from normal, Bernanke said. Continued improvement ... is likely to require stronger growth in final demand and production.
The swift decline in the U.S. unemployment rate in recent months, to a three-year low of 8.3 percent in January from 9.1 percent in August, has surprised economists both within and outside the Fed given the economy's relatively soft performance.
Last year, the economy expanded only 1.7 percent, although the fourth quarter proved to be the strongest.
The decline in the unemployment rate over the past year has been somewhat more rapid than might have been expected, given that the economy appears to have been growing during that time frame at or below its longer-term trend, Bernanke told the U.S. House of Representatives Financial Services Committee.
Bernanke's tentative outlook knocked the Dow Jones industrial average below the symbolic 13,000 level it had closed above on Tuesday. The Dow closed off 53 points, or 0.4 percent. It is up 2.5 percent on the month.
Stock prices had been marching higher all year on optimism about gathering economic momentum.
While Bernanke's tenor was dovish, the lack of a direct allusion to the possibility of a third round of so-called quantitative easing also undercut prices for government bonds and pushed the dollar up. Gold prices slumped 3 percent, their biggest one-day drop in 2-1/2 months.
Bernanke implied that the Fed was no closer to QE3 ... Investors were disappointed, said Cary Leahey of Decision Economics in New York.
Minutes of the Fed's January meeting released earlier this month suggested a consensus for more bond purchases would only emerge if the economic outlook worsened.
In a report prepared for its next meeting on March 13, the Fed said on Wednesday that the economy has expanded modestly since the start of the year, with hiring picking up in some areas.
The U.S. central bank cut overnight interest rates to near zero in 2008 and has bought $2.3 trillion in bonds in an effort to keep interest rates low and boost economic activity.
After a policy meeting last month, the Fed said benchmark rates would stay exceptionally low through late 2014.
Bernanke made clear on Wednesday that the pledge referred specifically to the current zero to 0.25 percent range for overnight rates. Some analysts had speculated it could encompass a somewhat higher but still historically low rate level.
Sustaining a highly accommodative monetary policy stance is consistent with the Fed's goals of achieving full employment with low and steady inflation, he said.
Asked whether the Fed was hurting savers with its easy monetary policy, Bernanke said a case could be made that interest rates should be even lower and that savers would benefit from a stronger economy.
It is arguable that interest rates are too high, that they are being constrained by the fact that interest rates can't go below zero, he said.
Cleveland Federal Reserve Bank President Sandra Pianalto on Tuesday said it could take four to five years to ratchet the jobless rate down to about 6 percent.
SAYS OIL CUTS BOTH WAYS
Bernanke also addressed the recent rise in oil prices, which he said could both raise inflation for a time and curb spending. Gasoline prices have moved up ... (which is) a development that is likely to push up inflation temporarily while reducing consumers' purchasing power, he said.
Strong jobs and factory data since the Fed last met have calmed fears U.S. growth would slow sharply early this year, and have led economists to scale back expectations for a further easing of monetary policy.
But tensions between Western nations and Iran over Tehran's nuclear ambitions have escalated, threatening a repeat of 2011 when a spike in energy prices hit the recovery hard.
Some financial market participants thought Bernanke's nod to potential price pressures from energy costs, however qualified, marked a heightened level of vigilance on inflation.
Any acknowledgement of inflationary pressures by the Fed could potentially shut the door on additional stimulus, said Ashraf Laidi, chief global strategist for City Index in London.
Nervousness about oil supplies has pushed prices for crude to 10-month highs, although prices fell on Wednesday as U.S. data showed higher-than-expected oil inventories.
Bernanke also warned that the U.S. recovery could come off the rails in 2012 if Congress failed to take action to address a massive fiscal cliff of tax increases and spending cuts due to kick in early that year.
I hope that Congress will look at that and figure out ways to achieve the same long-run fiscal improvement without having it all happen at one date, he said.
However, Bernanke played down risks to the United States from a likely euro zone recession.
If Europe has a mild downturn, which is what they are currently forecasting, and if the financial situation remains under control ... the effect on the U.S. might not be terribly serious, at least it probably would not threaten the recovery, he said.
(Additional reporting by Richard Leong in New York; Writing by Mark Felsenthal; Editing by Andrea Ricci, Tim Ahmann and Andrew Hay)