Inflation threat keeps Fed in check

SAN DIEGO/LOS ANGELES Tue May 1, 2012 5:42pm EDT

File photo of Richard Fisher, president of the Federal Reserve Bank of Dallas, at the 2009 Albert H. Gordon Lecture on February 23, 2009. REUTERS/Brian Snyder

File photo of Richard Fisher, president of the Federal Reserve Bank of Dallas, at the 2009 Albert H. Gordon Lecture on February 23, 2009.

Credit: Reuters/Brian Snyder

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SAN DIEGO/LOS ANGELES (Reuters) - The risk of inflation is keeping the Federal Reserve from doing more to support the U.S. economy, according to comments from several top Fed officials that reinforced the notion the central bank is happy to stand pat for now.

Five policymakers weighed in on Tuesday on how the U.S. central bank intends to deal with possible threats to the economic recovery. They include volatile oil prices, Europe's debt troubles, and a looming "fiscal cliff" of scheduled U.S. tax increases and spending cuts.

With inflation very close to the Fed's target of 2 percent, the officials seemed hesitant to rock the boat with more bond buying - even though unemployment remains high at 8.2 percent.

Atlanta Fed President Dennis Lockhart said inflation can run "a bit" above the Fed's 2-percent target, but he would be concerned if it ran at 3 percent or higher, and policymakers should aim for the rate to gravitate back toward that target.

"As a practical matter, running higher inflation ... I just don't see happening. Not intentionally," said Lockhart, a voter this year on the Fed's policy-setting panel, in comments at the 2012 Milken Institute Global Conference in Beverly Hills, California.

"In my mind," he added, "the inflation target is always something that you're always trying to gravitate toward."

In January, the Fed took the historic step of formally setting an inflation target of 2 percent. At the same time, it made a conditional pledge to keep interest rates "exceptionally low" until at least the end of 2014 - a statement it repeated last week to help revive an economy slow to recover from recession.

Inflation is running very close to the new target. Headline inflation receded to a rate of 2.1 percent in March, though core inflation has risen slightly in the last several months.

Philadelphia Fed President Charles Plosser, speaking at a separate conference in San Diego, warned that letting inflation rise could undermine the Fed's credibility, and would be unlikely to boost employment anyway.

"Credibility is very fragile, things can happen that you can lose it very quickly," said Plosser, who does not have a policy vote this year. "The public has a right to expect the central bank to keep inflation near its target of 2 percent over the medium term."

SOME SEE ROOM FOR MORE STIMULUS

Chicago Fed President Charles Evans, opposite Plosser on the Fed's philosophical spectrum of policymakers, urged an inflation "cushion" up to 3 percent that would let policymakers help the economic recovery along and cut the unemployment rate, which in March was still high at 8.2 percent.

The Fed has a "tremendous" amount of room to ease policy more, in part because the United States is not likely to see a "burst" of inflation, said Evans, a policy dove who has long endorsed more bond buys.

In late 2008 the Fed slashed interest rates to near zero and it has bought $2.3 trillion in long-term securities in an unprecedented drive to spur growth and revive the economy after the worst recession in decades.

But the U.S. recovery, especially in jobs, has been slow and economic growth has been erratic. Still, when the Fed launched its second round of bond buying in late 2010, officials had been worried about deflation. That is no longer the case.

Last week, the central bank slightly raised its inflation forecasts through the end of 2014, a move some took to mean it was less inclined to embark on a third round of bond buys, known as quantitative easing (QE3).

The Fed may need QE3 if the jobless rate gets "stuck" at around 8 percent or inflation drops well below 2 percent, San Francisco Fed President John Williams said at the Milken conference.

But Williams, who has a vote on the Fed's policy-setting panel this year, made it clear he does not expect the economy to underperform in such a way. He added that the Fed would "take the punch bowl away" if inflation picks up above 2 percent in a sustained way.

Jeffrey Lacker, head of the Atlanta Fed, speaking in Washington, warned the further easing would only raise inflation pressures and not do much for economic growth.

(Reporting by Ann Saphir in San Diego, Tim Reid in Los Angeles and Jonathan Spicer in New York; Writing by Jonathan Spicer; Editing by James Dalgleish, Jeffrey Benkoe, Jan Paschal, Andrew Hay)

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