The slump in the US housing market will prove a "significant drag" on economic growth, Federal Reserve chairman Ben Bernanke has warned.
Ben Bernanke knows that economic confidence is still fragile
Financial markets had stabilised since this summer's turbulence, he noted, but the full effects of the credit squeeze may not yet have been felt.
The Fed moved to restore confidence in financial markets by cutting interest rates by a half point last month.
Mr Bernanke pledged to act "as needed" to underpin the economy.
The US economy is expected to grow less quickly in the final quarter of the year than first thought while growth forecasts for next year have also been revised down by experts.
At the same time, recent economic indicators on employment, export levels and retail spending have been more positive.
Retail sales growth was stronger than expected last month while figures for new jobs created topped the 100,000 mark in September.
Speaking in New York, Mr Bernanke said it would take some time for Wall Street to recover from the credit squeeze, triggered by concerns about banks' exposure to sub-prime mortgage debt.
"Conditions in financial markets have shown some improvement since the worst of the storm in mid-August but a full recovery of market functioning is likely to take time and we may well see some setbacks," he said.
"The further contraction in housing is likely to be a significant drag on growth in the current quarter and through early next year."
Economists are divided over whether the Fed will cut rates further from their current 4.75% mark when policymakers meet again at the end of the month.
Mr Bernanke said there had only been "tentative" signs of tightening in the labour market while growth in incomes still continued to be robust.
"However, it remains too early to assess the extent to which household and business spending will be affected by the weakness in housing and the tightening in credit conditions," he added.
Separately, leading mortgage financiers have said it will take several years for the housing market to pull out of its current slump.
A senior official from Fannie Mae told a conference in Boston that he expected prices to fall 4% next year before flattening out in 2009.