Nov. 16 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said economic “headwinds” of reduced bank lending and a weak labor market will probably restrain the pace of the U.S. economic recovery, warranting continued low borrowing costs.

“Significant economic challenges remain,” Bernanke said in a speech today to the Economic Club of New York. “The flow of credit remains constrained, economic activity weak and unemployment much too high. Future setbacks are possible.” He added that the Fed is “attentive” to changes in the dollar’s value and “will help ensure that the dollar is strong.”

The central bank chief gave no indication he favors raising interest rates anytime soon. Bernanke repeated the key sentence from the Nov. 4 statement of Fed policy makers, who reiterated that interest rates will stay very low for an “extended period” as the central bank seeks to maintain a recovery from the deepest recession since the 1930s.

“Of course, significant changes in economic conditions or the economic outlook would change the outlook for policy as well,” Bernanke said in Manhattan in his first talk since the Fed’s Open Market Committee met this month. The Fed has a “wide range of tools” for tightening credit “when the economic outlook requires us to do so,” he said.

Retail Sales Rise

A government report today showed October retail sales in the U.S. rose 1.4 percent, more than anticipated, as demand for autos climbed, easing concern households will curtail spending after government incentives ended. A report from the Federal Reserve Bank of New York today showed manufacturing in the region expanded in November for a fourth straight month.

“The increases in productivity we have seen so far are so large, so strong, that I am a bit skeptical they can be maintained going forward,” Bernanke said in response to a question after the speech. Firms will find that “as demand begins to strengthen they will need to bring more workers back on.”

U.S. stocks rose, with the Standard & Poor’s 500 Index increasing 1.8 percent to 1,113.27 at 2:21 p.m. in New York. Treasuries extended gains, pushing the yield on the 10-year note down eight basis points, or 0.08 percentage point, to 3.34 percent.

The dollar, which traded at $1.4969 against the euro before the speech, declined to $1.5002.

The U.S. currency saw a “marked increase” because investors flocked to stronger markets during the financial crisis, Bernanke said. Now that markets have improved and the global economy has stabilized, “these safe haven flows have abated, and the dollar has accordingly retraced its gains. The Federal Reserve will continue to monitor these developments closely,” he said.

Dollar Value

“We are attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability,” Bernanke said. “Our commitment to our dual objectives, together with the underlying strengths of the U.S. economy, will help ensure that the dollar is strong and a source of global financial stability.”

The recent increase in commodities prices probably reflects a global economic expansion, especially in emerging markets, and the decline in the dollar, he said.

“It is inherently extraordinarily difficult to know whether an asset’s price is in line with its fundamental value,” Bernanke said in response to an audience question. “It’s not obvious to me in any case that there’s any large misalignments currently in the U.S. financial system.”

Gold Climbed

The price of gold has climbed 54 percent in the past year to $1,134.88 an ounce, reaching a record today for the fourth time in six sessions. Crude oil is up 77 percent in 2009.

Bernanke’s remarks on the dollar “strike me as ineffectual jawboning,” given it was at the end of a speech about why the Fed isn’t prepared to raise interest rates, said Stephen Stanley, chief economist at RBS Securities Inc. in Stamford, Connecticut.

“I’m sure the Fed wants world peace too, but there’s only one way that the Fed can strengthen the dollar, and Bernanke was crystal clear that the FOMC is not going there for ‘an extended period,” said Stanley, a former Fed economist.

The Fed, while trying to pull the economy from the recession, has held the benchmark lending rate close to zero since December while using asset purchases as its main policy tool. The $1.4 trillion in purchases of housing debt are set to end in March, while the Fed completed buying $300 billion of Treasuries in October.

Economic Growth

The unprecedented monetary stimulus helped fuel a 3.5 percent pace of growth during the third quarter. Economists expect an expansion of 2.6 percent next year and 3 percent in 2011, the median estimates in a Bloomberg News survey of forecasters this month. Fed policy makers gave updated economic projections at the last FOMC meeting, which will be released Nov. 25 as part of minutes of the session.

“I expect moderate economic growth to continue next year,” the 55-year-old chairman said, without giving a specific forecast. Demand is showing “signs of strengthening,” and housing, even with “important problems” such as foreclosures, may “become a small positive for growth” in 2010, he said.

Bernanke devoted the majority of his speech to bank lending and the labor market, saying they are “two of the principal factors that may constrain the pace of the recovery.”

“Banks’ reluctance to lend will limit the ability of some businesses to expand and hire,” Bernanke said. “I expect this situation to normalize gradually, as improving economic conditions strengthen bank balance sheets and reduce uncertainty; the fallout for banks from commercial real estate could slow that progress, however.”

Record Low

The Fed said last week that U.S. banks kept tightening lending standards for companies and consumers last quarter, reinforcing the central bank’s decision to leave its benchmark interest rate at record lows for a long time. At the same time, the number of banks making it tougher to borrow diminished, the Fed said in its quarterly Senior Loan Officer survey.

Bernanke said the labor market is an “area of great concern.” The U.S. jobless rate rose to 10.2 percent in October, the first time it’s exceeded 10 percent since 1983, and an additional 190,000 cuts from payrolls brought job losses to 7.3 million since the recession began in December 2007.

“Jobs are likely to remain scarce for some time, keeping households cautious about spending,” Bernanke said. “As the recovery becomes established, however, payrolls should begin to grow again, at a pace that increases over time.”

Growth Moderate

Still, “the unemployment rate likely will decline only slowly if economic growth remains moderate, as I expect,” he said.

Inflation “seems likely to remain subdued for some time,” Bernanke said, echoing the Nov. 4 FOMC statement that said price increases will stay “subdued for a time” given “stable” expectations for longer-term inflation.

The Fed’s preferred inflation gauge, which excludes food and energy prices, rose 1.3 percent in September from a year earlier, below the 2 percent goal preferred by the majority of Fed policy makers.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net; Michael McKee in New York at mmckee@bloomberg.net.

Last Updated: November 16, 2009 14:32 EST