WASHINGTON A bellwether Federal Reserve policymaker on Tuesday downplayed concerns about weakness in the global economy, saying the U.S. central bank should only delay an interest rate hike next year if inflation or wages fail to perk up.
John Williams, president of the San Francisco Fed, said in an interview with Reuters that the first line of defense at the central bank, if needed, would be to telegraph that U.S. rates would stay near zero for longer than mid-2015, when he currently expects them to rise.
If the outlook changes "significantly," with inflation showing little sign of returning to the central bank's 2-percent target, he said he would even be open to another round of asset purchases.
The comments from Williams, seen as a good barometer of the views of Fed Chair Janet Yellen, suggest the central bank has been little moved by growing concerns in financial markets over weakness in Europe and China, and remains on track to lift rates. In the interview, Williams repeated he is comfortable with his call for a rate hike about nine months from now.
But "if inflation isn't moving above 1.5 (percent) and we get stuck into that gear, that would argue for a later liftoff," he said. "If we don't see any improvement in wages, that would be a sign that we still have a lot of slack in the economy and we are not getting any inflationary pressure to move inflation back to 2 percent."
MARKETS NOT FAR FROM FED RATE VIEW
A key adviser to Yellen for years, Williams will rotate into a voting spot on the Fed's policymaking panel next year when the central bank is widely expected to start moving benchmark borrowing costs higher for the first time in nearly a decade.
As signals of European weakness grew stronger last week, investors pushed back their expectations for when the Fed would raise rates from June to September of next year, and they see a more gradual pace of rate hikes than predicted by Fed officials.
Asked about shifting investor bets, Williams expressed little concern, saying markets had a fundamentally correct view of the likely path of Fed policy.
"If the problem we are facing is the difference of a couple of (Fed) meetings, I really think those are not that meaningful," he said. "As the data come in, as the forecasts evolve, one view or another will be proved right."
Rather than reflecting a misreading of the Fed's intentions, low rates for 10- and 30-year U.S. government bonds instead show doubts about the global economy and other issues, Williams said. "The markets are pricing in a lot of other things that might happen and a lot of those are negative," he said.
If U.S. economic growth does pick up, Williams said the Fed could raise rates sooner than currently expected. But the bigger concern is a downturn, he said.
The Fed next meets on Oct. 28-29, when some policymakers are pushing to ditch a promise to wait a "considerable time" before raising rates, given a sharp drop in the U.S. unemployment rate to 5.9 percent. Williams wants to leave that phrase intact for now, but said the central bank could adjust it as the outlook evolves.
The Fed is set to wrap up its third round of massive asset purchases, known as quantitative easing, or QE, later this month, leaving it with some $4.4 trillion on its balance sheet.
Williams said the purchases were successful in helping extricate the economy from the 2007-2009 recession, and that he would not hesitate to use QE again, if needed.
"If we really get a sustained, disinflationary forecast ... then I think moving back to additional asset purchases in a situation like that should be something we should seriously consider," Williams said.
If the Fed starts to tighten policy and the economy stumbles, he said policymakers should have "no trepidation" about reversing course and returning rates to zero. Still, he said it is best to patiently keep rates low for awhile longer given the sharp risks of hiking too early.
Thomas Simons, an economist at Jefferies in New York, said the Fed "wants to avoid the perception that they are 'out of bullets' if economic performance takes a turn for the worse." But right now, he wrote in a note to clients on Williams' comments, "that is not the Fed's base case expectation at all."
Europe, which faces an elevated risk of a new recession and, according to the International Monetary Fund, a significant chance for an outright bout of deflation, has emerged as a central concern at the Fed. China was also flagged as a concern in minutes from the last Fed meeting in September.
Though the European Central Bank has acted forcefully to protect the euro zone, "the concern is the next steps that they may need," Williams said. "That worries me a little bit. Will their policy response be as timely and aggressive as needed?"
(Reporting by Ann Saphir and Jonathan Spicer; Additional reporting by Howard Schneider and Michael Flaherty; Editing by Tim Ahmann and Paul Simao)