Inflationary pressures in the U.S. economy are likely to ebb but there is not enough proof in the data so far to feel reassured, Federal Reserve officials said on Thursday.
And with risks to both inflation and growth on the rise, policy-makers gave no indication they plan a change to the Fed's steady-as-she-goes stance on interest rates.
"The best course for policy is watchful waiting," San Francisco Fed President Janet Yellen said late on Thursday in a speech to the Money Marketeers of New York University.
"The current stance of policy is likely to foster sustainable growth with a gradual ebbing of inflation over time. However, the inflation risks are skewed to the upside," Yellen said.
Earlier, Richard Fisher, the Dallas Fed president, told a group of investment advisers in Austin that he wants to see "verified" a reduction in inflation trends and expectations.
Fisher and Yellen spoke less than two weeks before the next scheduled meeting of the U.S. central bank's policy-setting Federal Open Market Committee on May 9. Neither is a voting member of the FOMC this year.
Financial markets expect the Fed to hold its benchmark fed funds rate at 5.25 percent at least through its May and June meetings. The FOMC last raised interest rates in June 2006.
Awash In Money
Fisher said there was plenty of liquidity in the global economy and that accounted for the shape of the so-called yield curve, which measures the relative risks investors see between short- and long-term securities.
In the past, an inverted yield curve -- in which rates on long-term securities are lower than those on short-term securities -- has been associated with a heightened risk of recession, but Fisher and Yellen both played down that concern.
The yield curve currently is virtually flat.
"Declines in risk premia are ... understandable against the background of sustained, robust growth worldwide, the concomitant reduction in volatility of the global macro-economy, and less inflation risk," Fisher said.
Fisher also played down worry that rising mortgage defaults, a spinoff from problems in the subprime mortgage market that services the riskiest borrowers, could tip the economy into recession.
"I don't think it will pose the kind of systemic risk that we are paid to worry about," Fisher said. "There are offsetting forces that will continue to carry the economy forward, at a slower pace, but keeping us from slipping into recession."
Default rates on subprime loans for borrowers with tainted credit have soared, and dozens of subprime lenders have gone out of business this year.
Yellen said the problems with subprime mortgages raise issues for bank regulators but were unlikely to have a big effect on the overall U.S. economy.
"My best guess is that real GDP will pick up a bit in 2007," she said.
Still, Yellen said the housing downturn would affect economic growth for a while.
"I still see a substantial drag from housing" on the economy, she later said in a question-and-answer session.
Yellen also spoke at length about the potential that trend productivity growth in the U.S. economy might have slowed, with wide-ranging implications for the jobs market, business investment, trend GDP growth and the rate of inflation.
"The implication for inflation is that real GDP would have to grow at a slower rate than we previously thought was necessary to generate more slack," she said.
Trade Promotes Reform
Fed Governor Frederic Mishkin, also speaking on Thursday, steered clear of any comment on current economic conditions and monetary policy in speech on globalization to the International Monetary Fund.
Mishkin reprised a familiar theme that freer trade will help promote financial reform in key economies, including China's, and that it is in the global economy's best interest for rich countries to keep markets open to emerging economies.
"We are seeing how the globalization of trade is driving financial reform in China," Mishkin said. "Although it has taken time, globalization is helping to generate the demand for an improved financial system, which is driving the reform process."