The US top central banker performed a U-turn today after giving warning that the world's largest economy faces "significant downturn risks" as stress across America's financial markets increases, unemployment continues to soar and the housing slump shows no sign of recovery.

Ben Bernanke, chairman of the US Federal Reserve, told the Senate Banking Committee in Washington this morning that the US economy is facing "numerous difficulties" and indicated that the central bank's rate-cutting programme was failing to contain the crisis afflicting the American economy.

Mr Bernanke's comments were interpreted by Wall Street as a sign that there will be no interest rate increases until well into next year. In June, Mr Bernanke had given hope to investors when he said he believed downside risks to US economic growth had diminished. After that statement to Congress, Wall Street had priced in three interest rate rises from the current level of 2 per cent to 2.75 per cent. But, today, traders assumed that there would be no increase in the cost of borrowing for the short term and futures contracts on near-term federal funds fell.

Fears that the US economy will slide into a protracted recession hit the New York stock market. The Dow Jones Industrial index fell by almost 200 points as soon as Wall Street opened but, by late morning, the benchmark index was down just 51 points to 11,003, its lowest level since July 2006.

Kevin Logan, senior economist at investment bank Dresdner Kleinwort in New York, said: "Bernanke has changed his tune. In June, he said that he didn't think it was all that bad. Now, six weeks later, he is saying that there are significant downside risks. He has basically been forced to face the data that has come out over the last six weeks, which shows that the US economy is deteriorating. House sales are down 2 per cent, car sales down 5 per cent, consumer confidence is pointing to a 28-year low, and the price of gasoline is up 17 per cent. A lot of information has come out since June, which shows that the US is in a much more precarious state than he thought."

Mr Bernanke's comments come at a highly nervous time in the US. Two days ago, the Fed and the US Treasury Department sought to rescue Fannie Mae and Freddie Mac, the mortgage giants, which ultimately finance more than half of Americans' mortgages, by offering to throw them a financial lifeline. The crisis for the mortgage groups illustrated that problems in the US housing market are far from over.

Today, the Fed published new economic projections and said that it now believes inflation will be higher this year than previously thought, with prices rising as high as 4.2 per cent. Growth for the year is expected to be sluggish — at best 1.6 per cent growth — but not as bad as previously forecast, helped by Washington's $168 billion (£84 billion) tax rebate stimulus package. The unemployment rate, which could rise as high as 5.7 per cent this year, is the same as earlier projections.

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