Portales' Kos: No Fed rate hike on tap

By Ros Krasny

NEW YORK (Reuters) - Worries about a spike in U.S. inflation are overdone, and as a result the Federal Reserve is unlikely to raise interest rates for at least the rest of 2009, a former top Federal Reserve official said on Wednesday.

Dino Kos, managing director at the research firm Portales Partners, said U.S. economic growth is likely to be tepid when the nation emerges from recession, with gross domestic product growth of 1 to 2 percent likely in 2010.

"Two percent would look really, really good," Kos said at the Reuters Investment Outlook Summit in New York.

Kos was executive vice president and head of the Markets Group at the New York Fed from 2001 to 2006, responsible for the implementation of monetary policy directives and reporting to the policy-setting Federal Open Market Committee.

A recent jump in interest rates on U.S. Treasury debt represents a "normalization" from levels reached when the economic outlook was extremely bleak, rather than panic about inflation, Kos said.

"It's hard to see upward pressure on inflation in the near term," he said. "There is an enormous amount of slack in the economy."

U.S. consumer prices for May fell by 1.3 percent year on year, the largest decline since 1950, the Labor Department reported on Wednesday.

Inflation hawks inside and outside of the Fed have focused less on the U.S. output gap, or how far the economy is from its "potential" level, and more on the huge expansion of the Fed's balance sheet.

But Kos, echoing comments made by Chicago Fed President Charles Evans on Monday, said there is no sign of the credit expansion that would be a precursor to inflation. Bank lending has fallen this year, he noted.

Looking ahead, the trend rate of GDP growth in the United States is likely to be lower than the 3 percent to 3.25 percent that was often assumed in the past -- mostly likely in the low 2 percent range, he said.

Kos said the Federal Open Market Committee will face "a communications challenge" at its policy meeting next week, on June 23-24, and over the next several months as a deep recession gives way to a tentative recovery.

The Fed will want to show it is supportive of recovery, and while policy-makers at some point will have to shift away from accommodation they will be leery of shifting too soon, he said.

Under Chairman Ben Bernanke the Fed wants to avoid the kinds of mistimed policy shifts the U.S. central bank made in 1937 and that Japan made in 1997, both of which prolonged economic downturns, Kos said.

When the time comes for the Fed to shift its stance it has "plenty of levers" to tweak its credit easing programs before actually raising the fed funds rate, which has been set at a range of zero to 0.25 percent since December.

(Editing by Leslie Adler)