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Fed's Stern comfortable with neutral rates

Written by: Staff

WASHINGTON, Mar 4 (Reuters) The U S Federal Reserve does not need to raise interest rates beyond a neutral range at present, a top Fed official said on Friday.

However, incoming data could change the view on whether neutral is still an appropriate stance for policy, said Minneapolis Federal Reserve Bank President Gary Stern.

Stern also told Reuters in an interview that since official interest rates now are at or near neutral, policy decisions have become more complex than earlier in the tightening cycle.

''I'm comfortable with it as of March 3,'' said Stern when asked about the view the Fed did not need to go beyond neutral to a contractionary stance, which would slow economic growth.

''This is going to be data-driven and I try to be receptive to incoming information. If the incoming data turned out to provide some surprises, or caused me to become more concerned about price stability than I am right now, that could change,'' Stern said.

Stern is the longest-serving member of the Fed's policy committee and in the past has been seen as one of its more hawkish members.

But his comments on Friday were more dovish on policy.

Minutes released this week showed that the Minneapolis Fed Bank voted in mid-January to hold the largely symbolic discount rate steady, a decision Stern described on Friday as a ''close call''. On January 31, the Fed went ahead and raised its benchmark federal funds rate to 4.5 per cent and the discount rate to 5.5 per cent.

The Fed has been steadily pushing up interest rates since mid-2004 to get borrowing costs back to more normal levels from an ultra-low 1 per cent.

''We are now in a place where decisions are somewhat more complex because we have covered a lot of ground and we are closer to, if not at, neutral,'' said Stern.

WAGES IN CHECK Financial markets widely expect the Fed at its next policy meeting in late March to raise the fed funds rate target to 4.75 per cent, and increase it again by midyear.

Stern, who is not a voter on interest rates this year, noted the usual central bank caveat that it is difficult to be precise about neutral policy, saying it is more likely to be a range than a single level.

He said he did not see broad-based wage pressures in labour markets, despite the recent dip in the unemployment rate.

''I don't think pressures on wages are broadly based. In some professions and in some markets, there are some wage pressures but even where that is the case it looks like productivity improvements have continued to offset those things pretty well,'' he said.

He expects core inflation will not ''deviate materially'' from the low range of recent years, although there could be some more spillover from high energy prices into core measures of inflation.

The Federal Reserve has said with the economy nearing full capacity, it is closely watching resource use, widely interpreted to mean the low unemployment rate currently at 4.7 per cent and rising industrial capacity use measures.

But Stern said he does not draw inflation implications from those variables.

''We really do operate in a global economy and with all the dramatic things that are happening in India, China and other places, I am not sure how meaningful capacity is as a concept.

''I need to question whether some of the former approaches are still as valuable,'' for the inflation outlook, he said.

Stern did not sound overly concerned about the effect of a slowing U.S. housing market on the broader economy, so long as incomes remain supported.

He said if housing prices do flatten out or decline, there could be some reversal of the wealth effects that have boosted consumer spending in recent years.

''But I think the quantitative impact may be modest, as long as employment keeps going up and incomes keep rising.'' Stern has headed the Minneapolis Fed since 1985, when Paul Volcker was still chairman at the Fed. The progress in the Fed's communication with the public over that time has been positive, he said.

Stern favours some sort of formal inflation targeting regime for the U.S. central bank, but said he didn't see the Fed agreeing quickly on such a shift.

New Fed Chairman Ben Bernanke, a long-time advocate of inflation targeting, has said he would move forward only if a consensus could be reached within the Fed.

''I don't think we are going to get a consensus very rapidly,'' said Stern, adding it partly depends on how high a priority Bernanke placed on moving toward adoption of a target.


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