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Fed's Pianalto Says Fed Keeping Close Eye On Inflation

The U.S. Federal Reserve is keeping an eye on inflation because of a risk that price growth will not moderate as much as it had expected, Cleveland Federal Reserve President Sandra Pianalto said on Tuesday.

"We still see risks to the inflation environment," Pianalto, thatwho has no vote this year on the Fed's policy-making panel, said in response to an audience question at a forum in Prague.

Her cautionary note on the inflation outlook echoed earlier remarks by Chicago Federal Reserve President Michael Moscow who said in Beijing that high inflation is a bigger concern for the United States than slower economic growth.

The policymaking Federal Open Market Committee has left its benchmark interest rate at 5.25 percent since June last year after a two-year string of increases. It reaffirmed its target after its latest policy-setting meeting on March 20-21.

Financial markets expect the Fed's next move to be to lower rates, but probably not until the second half of this year.

Pianalto said policymakers had kept rates on hold for the past six meetings to let them assess the impact of the 17 rate increases.

But she said the Fed had yet to see whether inflation was moderating as it had expected. "So we are keeping our eyes on inflationary pressures," she said.

The Fed's favoured inflation gauge, the core personal consumption expenditures index (PCE), in February was 2.3% higher than a year earlier, up slightly from 2.2 percent in January and above the 1% to 2% range that some Fed officials have described as a comfort zone.

Benefits of Inflation Targeting

In the statement following last week's meeting, the Fed pointed to inflation as its "predominant" concern, but dropped a reference to the possibility of "additional firming" in policy.

Instead, the central bank said only that any "future policy adjustment" would depend on the growth and inflation outlook, which markets took to be a step away from an inclination towards raising rates if necessary to tame inflation.

Pianalto acknowledged the U.S. economy was moving from a fast growth pace to a more moderate growth clip.

"(Recent) indicators have been mixed and our economy has slowed in 2006 and is slowing this year as a result of the adjustment that we are seeing in the housing sector. That has pulled back economic growth in the U.S.," she told the forum.

Pianalto also re-iterated her personal view that setting a numerical inflation objective would help to improve the central bank's communications.

Fed Chairman Ben Bernanke has long argued that Fed policy could benefit from the announcement of a numerical inflation target, saying a 1% to 2% increase in the core PCE index would be an optimal inflation rate.

But Pianalto said the Fed had no timeframe for potential announcement of changes to communications which it is reviewing.

In October 2006, the Fed said it needed more time to discuss the advantages and disadvantages of using a pre-set inflation goal.

"I personally believe that a numerical inflation objective does help communications both within the committee and externally but I am listening to all of my colleagues' issues and so am keeping an open mind," she added.

Earlier on Tuesday, Pianalto gave a speech about world currency reserves, saying the U.S. benefits from the fact that a large share of world currency reserves is held in dollars.

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