Economy slowing, price pressures rise: Fed's Hoenig

By Alister Bull

KANSAS CITY (Reuters) - The U.S. economy has slowed and inflation pressures are rising, but the outlook for 2008 is not all bad, Federal Reserve Bank of Kansas City President Thomas Hoenig said in defiantly hawkish remarks on Thursday.

"It is fair to say that the U.S. economy has been under considerable stress over the last several months. It is obviously related to real estate," Hoenig told a business luncheon hosted by The Central Exchange.

"But it is also interesting and important to keep in mind that we are also seeing rising inflation pressures, especially as we look at commodities and energy costs," he said.

Hoenig, who is not a voting member of the Fed's interest rate-setting committee this year, is perceived as an inflation hawk and voted against a rate cut last October, in favor of keeping policy on hold. He continued to voice concern.

"I would be very careful not to let inflation accelerate too long," he told the audience in response to a question, noting that the cost of bringing prices back into line could be very high for the economy.

"What experience tells me, once inflation beings to rise systematically ... even when the economy is slowing, once it gets to that point, the hardship for correcting that, at some point, is greater," he said. "So by delaying your attention to inflation, you actually accelerate your problem."

Since Hoenig dissented in October the Fed has cut rates again in the face of a weakening economic outlook. Hoenig acknowledged that the economy's future was currently very uncertain, but he refused to join the panic.

DEFIANT OPTIMISM

"I have every bit of legitimate concern about the U.S. economy. I am perhaps less pessimistic than some. While I know the economy is slowing, I think there is at least a case to be made that the economy will come out of this slow growth ... and hopefully return to our potential growth rate over the course of the year," he said.

He based this cautious optimism on continued solid labor markets, even after the jump in the U.S. jobless rate to 5 percent in December which he characterized as "still a fairly modest level of unemployment," healthy nonfinancial corporate balance sheets and a still strong international economy.

"There is a case, that is important as we look forward, for growth in the U.S. economy starting out slow -- one to 1-1/2 percent -- and building from there," he said.

Hoenig, in another hawkish remark, also noted that monetary policy works with a lag and the impact of the Fed's one percentage point of monetary policy easing since mid-September, lowering the federal funds overnight target rate to 4.25 percent, was only now being felt.

"Monetary policy is a long-run instrument and when you take an action it takes months, quarters, to have its final effect. So you have to be thinking in the long run," he said.

Hoenig said that if the economy weakened sharply, this would subdue inflation pressures, clearing the path to further cuts in the Fed's official interest rate. But if his hopes for a soft landing were borne out no more action may be warranted.

"If the economy does grow as we've suggested ... then where we are might be just fine," he said.

(Additional reporting by Burton Frierson and Pedro Nicolaci da Costa in New York; Editing by James Dalgleish)