Nov. 29 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said volatility in credit markets has ``affected'' the economy's prospects and policy makers must decide whether the risks between growth and inflation have now shifted.

``The outlook has also been importantly affected over the past month by renewed turbulence in financial markets,'' Bernanke said in a speech in Charlotte, North Carolina. ``The committee will have to judge whether the outlook for the economy or the balance of risks has shifted materially.''

Bernanke spoke a day after remarks by Vice Chairman Donald Kohn stoked investors' expectations for the central bank to lower interest rates for a third straight meeting Dec. 11. While the Fed chief discussed both the risks to growth and inflation, he indicated the central bank is watching for additional signs of a pullback in spending.

``Kohn's statement was a clear message to the markets that `we are prepared to cut rates if we have to,''' said Scott Minerd, who helps oversee about $26 billion in stocks and bonds at Guggenheim Partners Asset Management in Santa Monica, California. Bernanke's remarks ``give insight into what the process will be like'' as the Fed makes its decision, he said.

Treasuries have climbed this week, sending three-month bill yields below 3 percent for the first time since August, as concern over banks' willingness to lend drove investors to the relative safety of U.S. government debt. Treasury securities were little changed in Asian trading after Bernanke spoke.

Stocks Rally

At the same time, stocks have rallied on optimism the Fed will act to keep alive the economic expansion, now entering its seventh year. The Standard & Poor's 500 Index rose 4.4 percent in the past three days, to 1,469.72 at the close in New York.

The MSCI Asia Pacific Index added 1 percent to 162.33 as of 11:10 a.m. in Tokyo, heading for its highest close since Nov. 14.

Neither Bernanke nor Kohn repeated the language in last month's Federal Open Market Committee statement that risks between growth and inflation were ``roughly'' balanced. Economists interpreted the Oct. 31 statement as a signal policy makers preferred to leave rates unchanged for a time.

Uncertainty around the outlook is ``even greater than usual,'' requiring the Fed to be ``exceptionally alert and flexible,'' Bernanke said at an annual meeting of the Charlotte Chamber of Commerce.

Consumer `Headwinds'

``The combination of higher gas prices, the weak housing market, tighter credit conditions, and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead,'' Bernanke said. ``Continued good performance by the labor market is important for maintaining the economic expansion.''

Kohn said yesterday that officials must take account of the ``deterioration'' in credit markets when they next meet. Bernanke echoed that view.

``The Federal Reserve is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy,'' Bernanke said.

Federal funds futures show traders see a 100 percent chance of a reduction in the benchmark rate next month, with a 26 percent probability of a half-point move. After the 0.75 percentage point of cuts the past two meetings, that would make the most aggressive easing since the last recession in 2001.

Banks' Losses

Economists also predicted lower rates amid concern mounting losses on assets linked to subprime mortgages will cause banks to cut borrowing. Citigroup Inc., Merrill Lynch & Co., Barclays Plc and other banks have already warned of about $50 billion of losses.

Economic reports today indicated growth may falter after accelerating in the third quarter. New-home prices dropped the most since 1970 and jobless claims rose to a nine-month high. Government figures yesterday showed durable goods orders fell for a third month, the longest slump in 3 1/2 years.

Household spending data ``have been on the soft side,'' Bernanke said. ``The committee will have considerable additional information on consumer purchases and sentiment to digest before its next meeting.''

Economic data have been ``mixed'' since last month's FOMC meeting, the Fed chairman said. He noted that officials will have further reports, including November payroll figures, when they gather Dec. 11.

Forecasts Cut

President George W. Bush's economic advisers today followed Fed officials' move last week to lower their outlook for growth next year. Fed policy makers now expect U.S. gross domestic product to increase 1.8 percent to 2.5 percent in 2008, ``notably below'' the 2.5 percent to 2.75 percent they predicted in July.

Bernanke said inflation has remained ``moderate.'' Still, increases in the prices of food, imported goods and energy products may raise inflation and inflation expectations, he said.

``The effectiveness of monetary policy depends critically on maintaining the public's confidence that inflation will be well- controlled,'' Bernanke said. ``We are accordingly monitoring inflation developments closely.''

In financial markets, risk spreads have increased since the Fed met Oct. 30-31, an index tracked by Citigroup Global Markets Inc shows. The index rose to a high of 0.99 on Nov. 22 from 0.77 on Nov. 1, with 1 being the highest level of risk aversion. It was at 0.94 today.

Fed officials have tried to meet the surge in demand for cash, first lowering the cost of direct loans to banks in an unscheduled meeting in August. The central bank cut both the discount rate and its key rate in September and October. The New York Fed also said this week it plans a series of long-term repurchase agreements through year-end to ease funding shortages.

To contact the reporter on this story: Craig Torres in Washington at 1220 or ctorres3@bloomberg.net; or David Mildenberg in Charlotte, North Carolina at dmildenberg@bloomberg.net.

Last Updated: November 29, 2007 21:23 EST