January 8, 2008 / 1:44 PM / 12 years ago

Fed's Plosser: inflation risk makes policy harder

GLADWYNE, Pennsylvania (Reuters) - The risks of higher inflation in the face of slower economic growth will pose a challenge for monetary policy this year, Federal Reserve Bank of Philadelphia President Charles Plosser said on Tuesday.

Monetary policy today can do little to change a period of below-trend growth expected in the first half of 2008, Plosser told the Main Line Chamber of Commerce in a speech.

Still, “there are risks to the downside of even weaker economic growth.” If such weakness is prolonged that “may require further adjustments to policy,” he said, hinting at the possibility of further cuts in benchmark interest rates.

“At the same time we also face risks of higher inflation,” he said, and the Fed must remain “vigilant” on inflation and “be prepared to act as necessary.”

“I am concerned that developments on the inflation front will make the Fed’s policy decisions more difficult in 2008,” he said.

The Fed holds its next rate-setting meeting on January 29-30, and markets widely anticipate another rate cut after three consecutive cuts since September. Plosser, known as one of the Fed’s more hawkish officials, will become a voting member this year on the policy-setting Federal Open Market Committee.

The Fed has lowered its benchmark federal funds rate by a full percentage point since mid-September to 4.25 percent.

Plosser told reporters that he was open to further rate cuts and his decision on interest rates would depend on the economic outlook.

“The economy is going to be weak; the real question is how much weaker it’s going to get and whether (weakness is) going to spread to other sectors,” he said. “So it is a difficult time for monetary policy. Inflation is not dead. Expectations are tenuous. I have not made up my mind.”

Below-trend growth in the first half of the year would likely mean slower payroll growth for the first two to three quarters, and the unemployment rate may rise somewhat above 5 percent during the year, he said.

The jobless rate hit a two-year high of 5 percent in December and U.S. employers added a meager 18,000 jobs for the month. Plosser described the data as “pretty disappointing.”

Still, the U.S. economy was more resilient to higher oil prices than in the past, and Plosser said he expected growth to remain below trend through the first half of 2008 but to improve “appreciably” after that.

He saw little evidence now that financial strains, which surfaced in August from concerns about losses stemming from U.S. mortgage assets, were affecting the broader economy.

The downturn in the housing sector, which has dampened economic growth, would likely bottom out near the middle of the year, he said.

Plosser said recent data suggested inflation is becoming more broad-based, and he saw “more worrisome signs” of underlying price pressures as recent price gains were not solely based on higher energy prices.

While inflation expectations have risen only slightly since September they were more fragile than six months ago, he said.

Furthermore, “we should not rely on slow growth to reduce inflation,” he said.

Plosser projected the economy to grow 2.5 percent this year on a fourth-quarter-to-fourth quarter basis. That is at the high end of forecasts that the FOMC released in November.

On the financial sector, Plosser said the Fed alone cannot solve the issue of re-pricing risky assets and assessing counterparty risk.

He also urged banks to disclose losses. “Write-downs (by financial institutions) play a necessary and important role in restoring the health of financial markets,” he said.

He added that the two auctions held in December under the Fed’s new Term Auction Facility, aimed at easing credit concerns, were “successful” and he later said market conditions since the year-end had improved somewhat.

Additional reporting by Kevin Plumberg; Editing by Tom Hals

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