Fed's Fisher warns on growth but wary of inflation

FORT WORTH, Texas (Reuters) - The U.S. economy is in a slowdown that could steepen but inflation is also a threat that must not be ignored, the president of the Dallas Federal Reserve Bank, Richard Fisher, said on Friday.

"The mainstream analysis is that that slowdown will lead to economic anemia for a couple of quarters and then pick up again," Fisher told the Petroleum Club of Forth Worth. "There are some risks that we're seeking to manage but it may be that economic growth will be even slower than we envision."

Fisher is a voting member of the monetary policy-setting Federal Open Market Committee and voted against a half-percentage-point interest rate cut at its last meeting from fear of inflation.

Although acknowledging that growth was weak, Fisher said that data since the last meeting had not altered his assessment of the risks to the economic outlook.

He said that the economy should avoid "sustained negative growth" -- he declined to use the word "recession" -- and stressed the Fed must ensure that inflation expectations were contained, while signaling that it risks losing this battle.

"There is a question as to whether inflation expectations are well anchored," Fisher told reporters after the speech. "The 12-month number for the CPI is running at a very high level ... and the components of that (rise) are worrisome," he said, referring to the U.S. Consumer Price Index.

Treasury Inflation Protected Securities (TIPS) provide some guide to what investors expect U.S. inflation will be in the future, and the spread in yields between TIPS and comparable maturity Treasury paper has recently mounted.

Fisher said there were competing explanations for the change, but no hiding from the fact that it might be bad news.

"It has widened," Fisher said, referring to the TIPS spread. "The inflation premium being reflected by those instruments is not encouraging," he said.

The Fed has cut its trend-setting federal funds target rate by 2.25 percentage points since mid-September to 3 percent and is expected to ease again when policy-makers meet on March 18.

But there are signs that inflation pressures are building despite the slowdown in the pace of expansion.

FED DILEMMA

"We have to be mindful of that fact that we have to create the conditions for employment growth, at the same time be careful that we don't stir the embers of inflation," he said in the speech, "and that represents the horns of a dilemma ..."

Fisher said it will take some time for the full impact of the monetary stimulus that has been added through lower interest rates to kick in and boost the economy.

"Nobody knows with exact precision how much time it takes," he said, "At least six months and perhaps longer."

From a policy-making viewpoint, it is important to monitor the impact and try to make sure it is timed to be helpful rather than contribute to inflation pressures, he said.

"What one has to be concerned about is that, having taken the actions we've taken in order to bolster growth ... that we don't have this rubber hit the road just as we are having inflation act upon us at a level that is uncomfortable for policy-makers."

The annual inflation rate, measured by the CPI, was up a steep 4.3 percent in the 12 months through January, a rate that significantly whittles away the value of assets if left unchecked.

Fisher, in his speech, said the Fed's task currently was to find a balance between helping the economy avoid slipping into recession without taking policy actions that might fire inflationary pressures.

He said a fiscal stimulus package recently negotiated between Congress and the Bush administration, and signed into law by President George W. Bush, should prod businesses to make more new investments and could be helpful.

The $152-billion stimulus plan offers tax rebates to qualifying individuals and couples -- the aspect of it that has caught most public attention -- but also provides tax incentives for new productive investments.

"There's probably more to this in terms of the acceleration of capital expenditures than meets the eye," Fisher said. "That should be a stimulus, and if it's done properly, it should not necessarily lead to inflationary pressures," he said.

(Reporting by Alister Bull; Writing by Glenn Somerville and Alister Bull; Editing by James Dalgleish)