Fed officials keep open mind on policy moves

CHICAGO (Reuters) - Federal Reserve officials on Friday said they were keeping an open mind on whether U.S. interest rates need to be lowered further, a decision they said would be driven by data not yet in hand.

"It would be a mistake to bake in the cake more rate cuts," St. Louis Federal Reserve Bank President William Poole said after speaking at a conference in New York. "We will go meeting by meeting."

The U.S. central bank made an aggressive one-half percentage point cut to its benchmark lending rate on September 18, taking it down to 4.75 percent.

Financial market expectations of another cut at the Fed's next meeting on October 30-31, and for more down the road, are high. However, interest rate futures contracts, which gauge those expectations, knocked down the prospects for an October rate cut to 78 percent from 88 percent after Poole's comments.

In Murfreesboro, Tennessee, Atlanta Federal Reserve Bank President Dennis Lockhart said he had an "open mind" on the need for further interest-rate cuts given "somewhat mixed" recent economic data.

"My intention is very much to signal neutrality on that question. ... Where I come out on that question will depend on a spectrum of indicators," Lockhart told reporters after a speech at Middle Tennessee State University.

Poole is a voting member of the Fed's rate-setting Federal Open Market Committee this year, while Lockhart will not vote until 2009.

The latest economic data did little to bolster the case for further reductions in borrowing costs.

A report on Friday showed that U.S. consumers spent more freely in August, confounding fears that the housing market bust will soon turn spenders into savers.

Meanwhile, Chicago-area business activity was reported to have been slightly stronger than expected in September, suggesting growth in the nation's mid-section continues at a modest if unspectacular pace.

That brand of "moderate average growth" could continue over the next few years, said Poole, who hailed "the inherent resilience of the U.S. economy."

The Fed also received some good news on inflation on Friday. The government said the so-called core PCE price index -- the central bank's favored inflation gauge -- rose only 1.8 percent in the 12 months through August, the slimmest gain in more than three years.

Some Fed officials have said they would like to keep core inflation, which strips out volatile food and energy prices, in the 1 percent to 2 percent range.

Price pressures are moving "in the right direction," Poole said, although he added, "we could be disappointed next month."

INFLATION EXPECTATIONS WELL ANCHORED

Lockhart said inflation expectations, which have crept up in the wake of the Fed's rate cut, remained well anchored.

Janet Yellen, president of the San Francisco Federal Reserve Bank, who spoke during a panel discussion at the Boston Fed, said stable inflation expectations can help the economy weather shocks without igniting troubling inflation.

"Well-anchored inflation expectations, as we have had in the United States since the mid-1980s, can reduce ... the sensitivity of inflation to supply shocks," Yellen said.

Yellen argued that inflation targets can help central banks keep inflation expectations under wraps. The Fed has been considering whether to adopt a numerical inflation objective as part of broader discussion on communications issues that have been under way for more than a year.

"There may be potential benefits from choosing an inflation target that is low but positive," leaving a small "cushion" to guard against the risk of deflation, Yellen said.

LOST MONEY? TOUGH NOOGIES

Speaking at a conference in Chicago sponsored jointly by the Chicago Federal Reserve Bank and the International Monetary Fund, Fed Governor Frederic Mishkin said recent financial turmoil highlights how global markets remain vulnerable to systemic risks.

Answering questions from the audience, he stressed that the Fed's job was to ensure the economy stays on an even keel. "We're doing the best we can," he said.

Mishkin defended the Fed's decision to lower interest rates last week as a move to protect the overall economy, not a lifeline to investors who had misjudged risks.

"If you didn't do your due diligence -- tough noogies. But on the other hand you don't want to not do something just for the sake of punishing those people and hurt the economy along the way," he said.

(Additional reporting by Alister Bull in Murfreesboro, Scott Malone in Boston, Tamawa Kadoya and John Parry in New York, and Glenn Somerville in Washington)