Yellen: Fed faces unpleasant mix on prices, growth

By Ros Krasny

CHICAGO (Reuters) - San Francisco Federal Reserve Bank President Janet Yellen said on Friday that the U.S. central bank faces an "unpleasant combination" of risks to inflation and growth in setting interest rate policy.

"The U.S. economy is particularly exposed to downside risks from the unwinding of the housing bubble and disruptions in financial markets," Yellen said in remarks prepared for Banque de France's symposium on globalization and monetary policy in Paris.

"There is some slack now in the U.S. labor market and, if these downside economic risks materialize, quite a bit more slack could emerge," she said, which would tend to dampen inflation.

Still, Yellen said inflation risks were "roughly balanced" and that the Fed "cannot afford to take for granted that inflation expectations will remain well-anchored."

The Federal Open Market Committee will decide on its next policy move on March 18, and is widely expected to lower its benchmark lending rate to as low as 2.25 percent from the current 3 percent.

The FOMC has slashed the federal funds rate from 5.25 percent since mid-September in the face of weaker economic growth and dislocations in global credit markets -- even as inflation pressures have started to mount.

Yellen is not a voting member of the FOMC in 2008.

Yellen did not discuss the economic outlook at length in a speech devoted mostly to mulling reasons why global inflation has been relatively contained in recent years, even as oil, food and materials prices have spiked.

She said it would be "a mistake" to downplay the role of monetary policy, and the credibility of central banks in general and the Fed in particular, in holding down price pressures.

"Credibility accounts for why inflation appears generally to have become less persistent," Yellen said.

By contrast, the role of a global competition in tamping down inflation is "frequently overstated," she said.

"Whatever tailwinds may have resulted from falling non-commodity import prices waned as the dollar declined."

INFLATION DISAPPOINTING

Yellen repeated a comment from February that rising U.S. inflation recently has been "disappointing."

The personal consumption expenditures (PCE) price index has advanced by 3.7 percent over the past 12 months and at a 5.4-percent annual rate during the past quarter.