By Tamawa Kadoya
NEW YORK (Reuters) - The Federal Reserve's second in command on Wednesday signaled a readiness to cut interest rates again, acknowledging that financial market turmoil could slow the U.S. economy and the central bank must be flexible.
"Uncertainties about the economic outlook are unusually high right now," Fed Vice Chairman Donald Kohn told the Council on Foreign Relations in New York. "These uncertainties require flexible and pragmatic policy-making -- nimble is the adjective I used a few weeks ago."
U.S. banks have written off billions of dollars in recent weeks due to losses in the subprime credit market, provoking fresh turmoil in financial markets that had only just recovered from the extreme jitters set off by credit fears in August.
Kohn sent Wall Street stocks soaring, with the Dow Jones industrial average advancing over 300 points as investors read his remarks as a strong hint of another quarter point cut at the next Fed rate-setting meeting on December 11.
Kohn's sober assessment also coincided with a separate Fed report underlining the drag being exerted on the wider U.S. economy by the weak housing sector.
The Beige Book, based on reports from the 12 regional Federal Reserve branches, noted that seven Fed districts had reported a slower pace of growth, while conditions in the remaining five districts were modest or mixed.
"The national economy continued to expand during the survey period of October through mid-November but at a reduced pace," the Fed said.
Kohn explicitly nodded to the deterioration since the Fed last met to discuss policy, on October 30-31. At that meeting it lowered rates by a quarter point to 4.5 percent, but said the risks to growth and inflation were roughly balanced.
Since then investors have grown alarmed by weak economic data, opening a clear divergence between market expectations for future rate cuts and the impression created by the Fed in October that its easing campaign was finished.
Kohn helped to close that gap by acknowledging the recent drying up of liquidity, as banks hoard cash to offset further possible credit-related losses, had caught him off guard and was a cause for concern.
"I have to admit that, speaking for myself ... the degree of deterioration that has happened over the last couple of weeks was not something that I personally anticipated," he said in response to questions after his speech.
"Financial institutions became more cautious, and I think this process is one that we are going to have to take a look at when we meet in a couple of weeks," Kohn said, adding the central bank was looking at "lots" of different ways to supply liquidity to the markets.
His remarks contrasted sharply with comments from other members of the Fed's interest rate-setting committee, including a speech by Dallas Fed Bank President Richard Fisher that explicitly spelled out there was a split among policy-makers regarding the risks between inflation and growth.
"There are people at the (Federal Open Market Committee) table, myself included, that are very concerned about inflationary pressure. I don't think we're done in terms of getting it to where we want it to get," he told a community forum hosted by the Dallas Fed in Amarillo, Texas.
Fisher's words followed warnings from two other regional Fed bank presidents on Tuesday.
Chicago Fed chief Charles Evans said the stance of monetary policy was consistent with the Fed's objectives of steady growth and low inflation. Philadelphia Fed President Charles Plosser said that rate cuts risked inflation and could even slow the return of financial stability.
The difference between the tone of Kohn's comments and the others was spotted immediately.
"It sounded nothing like anything we've heard since the last meeting from other FOMC members," said Laurence Meyer, a former Fed governor attending the same event with Kohn. "It's not a surprise because the only FOMC members that can change the message are the vice chairman and the chairman."
(Additional reporting by Mark Felsenthal, Alister Bull, Tim Ahmann and Glenn Somerville in Washington and Ed Stoddard in Amarillo; Writing by Alister Bull; Editing by Neil Stempleman)