Fed's Yellen sees risks to U.S. recovery

PHOENIX (Reuters) - The U.S. economic recovery still faces many hurdles, including a persistently weak labor market and strained household budgets, Janet Yellen, President of the Federal Reserve Bank of San Francisco, said on Tuesday.

Yellen said in a speech to a local organization she was not worried about inflation, arguing instead that the possibility of a problematic drop in consumer prices remains the greater risk.

"The strength and durability of the expansion is in question," Yellen said. "Some of the rebound is due to temporary government programs and a swing in inventory investment that will not provide an ongoing source of growth."

Still, she credited the very same government efforts, in conjunction with unprecedented monetary stimulus from central banks worldwide, for reviving growth in the third quarter.

The U.S. economy expanded 3.5 percent during that period, following the worst recession in generations. Whether the private sector can pick up the slack once the government boost is gone remains to be seen, Yellen said.

"The danger is that demand may grow at too anemic a pace to support vigorous expansion," said Yellen.

Addressing the nation's battered housing market, Yellen said signs of stabilization were an important positive. But she cautioned that the high unemployment rate, currently at a 26-year high of 10.2 percent, raised the threat of a renewed wave of foreclosures that could again pressure home prices.

The outlook for commercial real estate is "worrisome," Yellen said.

Given the recession's toll, U.S. consumers are still strapped for cash, and stagnant incomes are not helping.

"High unemployment, weak job growth, and paltry wage increases are a recipe for sluggish consumer spending growth and a tepid recovery," said Yellen.

Another possible impediment to a vibrant recovery is the banking sector, which is still facing a mountain of bad loans, Yellen argued.

"It may take quite a while for financial institutions to heal to the point that normal credit flows are restored. The credit crunch hasn't entirely gone away," she said.

(Reporting by Pedro Nicolaci da Costa, Editing by Chizu Nomiyama and James Dalgleish)