Fed officials see slow recovery ahead

DALLAS/NEW YORK (Reuters) - Federal Reserve officials on Tuesday reiterated the central bank's view that recovery from the deep U.S. recession will be sluggish for some time, meaning there is no urgent need to rein in policies designed to stimulate growth.

Once the economy shows signs of self-sustaining traction the Fed should move actively to reverse its ultra-low interest rates and other extraordinary measures undertaken to lubricate credit markets -- but that time could be some way off, Richard Fisher, president of the Dallas Fed, said.

"When it comes time to tighten monetary policy, my colleagues and I will move with an alacrity that, if needed, will be equal in speed and intensity to that which we pursued monetary accommodation," Fisher said in a speech to the Texas Christian University Business Network in Dallas.

Still, with the housing market still on government-backed life support, bank lending still weak, and consumer spending likely to be capped by a new attitude of thrift, that time is not at hand, said Fisher, who is not currently a voting member on the U.S. central bank's policy-setting Federal Open Market Committee. He will next be a voting member in 2011.

Many economists believe the U.S. economy returned to growth some time in the current quarter, which ends on Wednesday -- technically ending a recession that started in December 2007, but carrying no guarantee of a fast recovery.

"My guess is that it will be a long time before we see growth strong enough and sustained enough to make an appreciable dent in excess capacity," Fisher said, adding that "muscle tone" is still lacking from the economy.

The New York Fed's first vice president, Christine Cumming, in separate remarks said recent data suggested the U.S. economy is starting to bottom out, but she sees little strength in the recovery.

"We view the risks as still very much skewed to the downside. In other words, a lot could still go wrong and we have to be careful," she said in a lecture at Eastern Connecticut State University.

"It seems it won't be the easiest and snappiest recovery ahead of us," said Minnesota native Cumming, who is now second in command at the New York Fed. She has been widely tipped as a candidate to replace Gary Stern as president of the Minneapolis Fed. Stern retired at the end of August.

Fisher said he expects the jobless rate, which hit a 26-year high of 9.7 percent in August, to rise to 10 percent. The labor market is typically a lagging indicator even when the economy returns to growth.

INFLATION BURIED UNDER SLACK

Fisher and Cumming both said price pressures muted by the huge amount of slack in the economy -- the gap between potential output and current levels of production and employment in what is the worst recession since World War Two.

"The risk appears to be deflationary or at least disinflationary in the medium term," said Fisher.

Still, he vowed to be "ever vigilant" on inflation given the long-term dangers posed by the expansion of the Federal Reserve's balance sheet as it attempted to shore up credit markets and the economy.

Fisher's suggestion that the reversal of policy, once it arrives, could be swift echoed comments made last week by Fed Governor Kevin Warsh.

Since Warsh's hawkish comments on Friday -- when he said that if policymakers wait until the economy has clearly returned to normal to change course it will be too late -- financial markets have started to anticipate more aggressive increases to the Fed's target interest rate, which has been set near zero since December 2008.

KICK AWAY THE CRUTCHES

Fisher said the Fed's program to support the home mortgage market by purchasing massive amounts of mortgage-backed securities had been a success -- but that real success would be achieved when government help is no longer critical.

"The Federal Reserve has been buying over 70 percent of the new mortgage originations in the MBS market," he noted.

Once those purchases are completed by the end of the first quarter of 2010, "we will have to see if the private markets pick up where we leave off."

U.S. house prices rose for a third month in July, according to the closely watched S&P/Case-Shiller composite index of house prices in 20 metropolitan areas. The 1.6 percent rise outpaced analysts' forecasts.

Even with the encouraging data, Cumming said the housing market "may not be totally out of the woods yet," adding that there remains "a lot of distress in the housing market to work through."

And Fisher said the market must be able to stand without government support to become "truly robust."

"There is, in my opinion, a limit to the life support that can be provided by either the Federal Reserve on the monetary front or the Congress on the fiscal front," he said.

(Editing by Leslie Adler)