Fed's Yellen says economy "all but stalled"

PALO ALTO, California (Reuters) - The U.S. economy has "all but stalled and could contract" in the first half of 2008, but the interest rate outlook is clouded, San Francisco Federal Reserve President Janet Yellen said on Thursday.

Her comments reflected those of Ben Bernanke, the chairman of the Federal Reserve, who told a Congressional committee on Wednesday that the U.S. economy may contract in the first half of this year.

"Economic prospects remain unusually uncertain, and the downside risks to growth are significant," Yellen said in remarks prepared for an outlook presentation to the Stanford Institute for Economic Policy Research.

"It appears that growth in consumption and business investment spending has slowed markedly after years of robust performance, and, as a result, the economy has all but stalled and could contract over the first half of the year."

Given the risks, Yellen said the Federal Open Market Committee must be "prepared to act in a timely manner to promote a return of the economy to a sustainable path."

The remark hinted that Yellen might favor additional cuts to the federal funds rate, the Fed's main monetary policy tool. Yellen is not a voter on the policy-setting FOMC in 2008.

While prepared to act, Yellen told reporters that she was "very uncertain" on the outlook for interest rates, and that future policy moves would be determined by the evolution of the economy.

"I am very uncertain about what will happen with the fed funds rate going forward ... I have a very open mind on the subject," Yellen said.

The funds rate has been slashed to its current 2.25 percent from 5.25 percent since mid-September. Financial markets anticipate another one-quarter point cut in the rate when the FOMC meets April 29-30.

Yellen said the funds rate is now "accommodative," at a real, or inflation-adjusted, level of zero or slightly above zero.

"I consider such accommodation an appropriate response to the contractionary effects of the ongoing financial shock and the housing downturn," she said.

Lowering the funds rate another notch, to a negative real rate, could find opposition from inflation hawks on the FOMC. Already, in March, Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser voted against the Fed's aggressive 75 basis point rate cut.

HOUSING SICKNESS LINGERS ON

Yellen said weakness in the housing market is expected to be a drag on the overall economy into 2009.

"It seems likely that the period of house price declines will not be over very soon ... this trajectory of house prices plays a critical role in the economic outlook."

The busted housing bubble only recently spilled over into the rest of the economy, and that lower housing prices were just one of several factors hitting consumer spending.

Given the weak growth, the U.S. jobless rate is likely to rise "into a range indicating the presence of some slack" from its February level of 4.8 percent, Yellen said.

Yellen said much of the recent news on inflation has been "disappointing," with core inflation at the top end of a range consistent with price stability, and commodity prices high.

"This is not a great time" to be enduring kinds of hikes in energy and food prices seen recently, Yellen said, adding that the Fed wants to avoid a 1970s-style wage-price spiral.

Still, she told reporters she is "less uncomfortable" with the inflation situation than some of her FOMC colleagues.

This year's anemic growth should tamp down price pressures, she said. "Inflation tends to fall noticeably during recessions."

In contrast to commodities prices, wage pressures have been only moderate over the past year, and "fairly robust" productivity gains have helped tamp down unit labor costs as well, Yellen said.

Yellen joined other Fed colleagues in defending the central bank's involvement in JPMorgan Chase's purchase of imploding investment bank Bear Stearns Cos.

The move was a way to head off a potential systemic crisis with "unacceptable consequences" for the whole U.S. economy, she said.

"Bear Stearns ... intended to file for bankruptcy. Doing so might well have led to widespread fears in the financial markets ... escalating problems in other highly leveraged institutions," Yellen said.

Yellen told reporters there is no guarantee that the worst losses by banks and other institutions from the mortgage mess and credit crunch are now over. "If the economy is poor, financial losses will be higher," she said.

(Editing by Neil Fullick)