March 4, 2008 / 7:37 PM / 12 years ago

FED FOCUS-Fed's hawks and doves duel over inflation outlook

WASHINGTON, March 4 (Reuters) - Senior Federal Reserve policymakers voiced conflicting views on the outlook for inflation and growth on Tuesday, exposing a split among U.S. central bankers that could influence interest rate moves.

Fed Board Governor Frederic Mishkin said the U.S. economy faced grave risks and inflation pressures would abate — remarks that will reinforce views that he backs further cuts in benchmark rates to buffer the economy.

“I see significant downside risks to this outlook. These risks have been brought into particularly sharp relief by recent readings from a number of household and business surveys that have had a distinctly downbeat cast,” Mishkin told the National Association of Business Economics in Arlington, Va.

The Fed has already slashed target interest rates by 2.25 percentage points since mid-September to shield the U.S. economy from a collapse in the subprime mortgage market that has chilled growth and sparked a global credit crunch.

Mishkin’s remarks were similar in tone to recent comments by Fed Chairman Ben Bernanke and Fed number two Donald Kohn. Both emphasized downside risks to growth over inflation.

Investors think these remarks signal the Fed will cut rates another half percentage point at its next meeting on March 18.

However, inflation has also been rising and other, more hawkish, policymakers have stressed this could spell trouble.

Dallas Fed President Richard Fisher, who voted against the last rate cut, when the Fed lowered its funds rate half a point to 3.0 percent on Jan. 30, said separately on Tuesday that weak growth was a milder threat than inflation.

“Containing inflation is the purpose of the ship I crew for,” Fisher told a conference in London.

“If a temporary economic slowdown is what we must endure while we achieve that purpose, then it is, in my opinion, a burden we must bear, however politically inconvenient,” he told the Society of Business Economists.

He also said the decline in the dollar to record lows since January and a climb in U.S. bond yields might reflect market worries that inflation could get out of control.

“All these signals could be aberrations — twitches in markets,” Fisher said.

“But they might also indicate that the markets are unnerved by the idea of further monetary accommodation in a world where commodity prices inch upward almost on a daily basis and labor costs escalate in Chinese factories,” he said.

His remarks followed recent hawkish comments from another voting member of the Fed’s interest rate setting committee this year. Philadelphia Fed President Charles Plosser said on Monday inflation expectations had crept higher and must be watched.

“They certainly bear our monitoring and careful assessment of what is going on. Once the genie is out of the bottle, it is hard to get it back in. We can’t wait too long for inflation expectations to materialize otherwise you get behind the curve,” Plosser said.

Fed-watchers think Bernanke and Kohn, backed by Mishkin and other dovish Fed officials, will prevail in guiding borrowing costs lower in the short term, but see the hawks influencing the debate about how low they go.

“The Fed will start to think a little harder after March 18,” said analyst David Jones of DMJ Advisers in Fort Myers, Florida.

“At 2-1/2 percent it moves them into negative real fed funds rate territory,” he added. “The real lesson of the 1970s is that you don’t go back to negative real interest rates and is an unwritten rule at the Fed, or you risk unmooring inflation expectations,” Jones said.

Fed officials say they are cutting rates to insure against a ‘negative feedback loop’ from credit market turmoil that sparks further economic weakness. Plosser said that as soon as markets calm, it will be time to raise rates again.

“I’m looking for some stability in financial markets because I think that (is) what we are trying to insure against — some downside risks there.

“As we get more comfortable with that ... that will be a time to think about ‘OK, things are functioning like they should, it is time to take this back’,” Plosser said. (Additional reporting by Emily Kaiser and Mark Felsenthal in Washington and Jamie McGeever in London; Editing by James Dalgleish)

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