Fed's Lockhart: growth weak, inflation easing

ATLANTA (Reuters) - The global credit crisis will chill U.S. economic growth well into next year but powerful steps to unlock financial markets have been taken and will work, a top Federal Reserve official said on Monday.

"We at the Atlanta Fed expect weakness to persist for some time into 2009 as credit markets gradually improve," Atlanta Federal Reserve Bank President Dennis Lockhart told the Buckhead Rotary Club.

"The thawing of credit markets is a necessary condition for a recovery back to levels of growth consistent with the economy's underlying potential," he said.

Lockhart is not a voting member of the Fed's interest-rate setting committee this year.

The Fed has slashed interest rates and pumped more than $1 trillion into financial markets to prevent a credit crisis, sparked by massive losses on U.S. home loans, from inflicting a deep and damaging recession on the U.S. economy.

It cut key rates by a half percentage point to 1.5 percent earlier this month in an inter-meeting decision that was coordinated with other central banks in an unprecedented move.

"A broad set of policies have been devised and forceful actions taken to mitigate the effects of this credit contraction. I believe these policies will work," Lockhart said.

Traders have priced in a cut in the Fed's benchmark overnight funds rate by at least 25 basis points by the time of its next scheduled policy meeting, on October 28-29. Prices for interest rate futures indicate a roughly 50 percent likelihood that the Fed will cut by a half point.

One potential obstacle to further rate cuts appears to be fading. Economists expect the U.S. inflation rate to fall sharply next year as prices for oil and other commodities continue to tumble due to fears about a global recession.

Lockhart noted price pressures were heading down.

"With the deterioration in economic conditions and the recent associated falloff in energy and many other commodity prices, I anticipate further dissipation of inflationary pressures.

"Nevertheless, given high inflation readings during the summer and into the fall, I'll continue to watch developments closely," he said.

U.S. headline consumer inflation peaked at a year-on-year rate of 5.6 percent in July and has since drifted back to a reading of 4.9 percent last month.

However, Lockhart did not worry that massive liquidity injections by the central bank risked sparking price pressures by boosting the money supply.

"I'm quite confident that the inflationary pressure that might come if the money supply were growing dramatically and growing in an unrelenting fashion. I'm quite confident that's not going to occur," he said, noting that the Fed conducts regular open market operations to manage money supply.

"It's been our practice to try to manage as best we can the overall monetary base without it just continually growing," Lockhart told the audience in response to a question.

Lockhart also pinned part of the blame for the crisis on the huge leverage that financial firms had been able to create through the use of derivatives, and said that regulation of the credit default swap market was firmly on the Fed's agenda.

"We at the Fed very much support the notion of moving to a central clearing house and a more standardized organization of the market," he said.

(Reporting by Alister Bull, Editing by Tom Hals)