October 5, 2017 / 1:20 PM / in 16 days

SF Fed's Williams: Low growth, low rates, likely here to stay

ST. LOUIS (Reuters) - The long-term trend in annual U.S. economic growth may be as low as 1.5 percent, signaling future interest rates will be lower than historical norms, San Francisco Fed President John Williams said on Thursday.

President and Chief Executive Officer of the U.S. Federal Reserve Bank of San Francisco, John Williams, addresses a news conference in Zurich, Switzerland September 22, 2017. REUTERS/Arnd Wiegmann

His downbeat forecast, perhaps the most pessimistic among his colleagues, also imply tough choices in coming debates over tax and other policies that, if Williams is correct, could feed inflation as much as economic growth.

Williams’ remarks, prepared for delivery at a conference of community banks and state bank supervisors, came as a warning of sorts, that the higher interest rates and wider spreads that previously boosted bank profitability likely won’t return.

“Like the pager, the Walkman, and the Macarena, we’re unlikely to see such rates return. Bottom line: In the new world of moderate economic growth, banks need to plan for lower rates,” Williams said, respectively referring to a precursor to the cell phone, a portable music player and a Latin-inspired dance popular in the 1990s.

Williams said the Fed needs to continue raising-short term rates, citing low unemployment and what he regards as a temporary dip in inflation.

Long-term rates should rise as well as the central bank reduces its own long-term asset holdings, he said.

But the long run will look different.

Due to sluggish growth and other structural economic factors, he said the estimated “neutral” Federal Funds has fallen to around 2.5 percent, around two percentage points below historical norms.

The neutral rate serves as a rough reference point for where the current round of interest rate increases may stop.

The spread between that and a 10 year Treasury bond, commonly around 1.5 percentage points, Williams said, may end up stuck at around 1 percent.

“Banks, and everyone else, need to prepare accordingly,” for a world where global interest rates are permanently lower, he said.

Williams’ outlook for the low neutral federal funds rate is not new.

But coupled with his trend growth figure - the lowest among his colleagues according to their most recent projections - it provides a sense of the limits he sees approaching.

If growth were to suddenly accelerate without some increase in productivity or other structural change to make that faster growth sustainable, “it could lead to an asset price bubble or other problems like high inflation. This is exactly what we want to avoid,” Williams said.

The administration of U.S. President Donald Trump has said its tax overhaul plan and other proposals will raise economic growth to 3 percent, a proposition many economists feel is either unrealistic or potentially inflationary if it is not structured to, for example, raise productivity.

Reporting by Howard Schneider; Editing by W Simon

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