Fed's Mishkin-Central banks must watch forex swings

WASHINGTON (Reuters) - Foreign exchange fluctuations can affect inflation and economic activity, and while the impact is usually modest, policy-makers must take currency swings into account, a Federal Reserve official said on Friday.

"Sizable depreciations of the nominal exchange rate exert fairly small effects on consumer prices across a wide set of industrial countries," Federal Reserve Board Governor Frederic Mishkin said in remarks prepared for delivery to a conference on monetary policy sponsored by the Norwegian central bank in Oslo.

"Nevertheless, exchange rate fluctuations can still have an effect on inflation and economic activity," he said. "Hence monetary policy-makers must continue to take these fluctuations into account to ensure that inflation expectations remain well anchored and that fluctuations in economic activity are minimized."

Mishkin's comments come as the dollar fell to fresh record lows against the euro EUR= on Thursday. There has been tension between U.S. and European officials over the Fed's aggressive interest-rate cutting campaign, which is intended to buffer the economy from the housing slump and a credit crunch, but which has also put upward pressure on the euro's value.

The Fed has cut rates by 2.25 percentage points to its current 3.0 percent in five steps since September.

For its part, the European Central Bank has been reluctant to lower rates out of worries about inflation. On Thursday, it kept interest rates unchanged at 4 percent, where they have stood since last June.

Mishkin said exchange rate fluctuations are less likely to have an adverse effect on inflation than they have in the past. The pass-through of exchange rate swings from producers to consumers is low and has declined over the past two decades, he added.

This weaker relationship between exchange rate swings and demand makes it easier for policy-makers to stabilize inflation and economic activity by adjusting interest rates, Mishkin said.

The Fed governor cautioned that some economic shocks may produce higher rates of pass-through than would normally be expected. But he also said economic models suggest that even the effects on inflation and output of a relatively large and sharp 10 percent decline in the value of the dollar are "fairly modest."

(Reporting by Mark Felsenthal; editing by Gary Crosse)