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Fed's Kroszner Says Inflation Still Main Concern

Reuters
Friday, 1 Jun 2007 | 7:23 AM ET

U.S. economic growth should rebound in the course of 2007 after hitting a soft patch in the first quarter and the main threat to the economy is inflation, a top Federal Reserve official said on Friday.

"I believe that the risks to the inflation outlook are primarily to the upside," Federal Reserve Board Governor Randall Kroszner told the Institute of International Finance in prepared remarks.

A copy of his speech was made available to media in Washington prior to delivery.

"The high level of resource utilization continues to have the potential to put additional upward pressure on inflation.

And, of course, higher oil prices and the possibility of further increases also pose an upside risk to inflation," he told the spring membership meeting of the IIF.

The Fed held interest rates unchanged at 5.25% at its last policy meeting on May 9, and minutes of that gathering released on Wednesday showed that policymakers still viewed inflation as their predominant concern.

But the tone of the minutes revealed slightly less worry about the risks posed to growth by the cooling housing market or the turmoil in the country's subprime mortgage sector, and Kroszner echoed this sentiment.

U.S. gross domestic product growth slowed to a 0.6% annualized pace in the first quarter, down from 2.5% in the previous three months, but Kroszner forecast the dip would be short-lived.

"Activity was held down in the first quarter, in part, by several factors that seem likely to prove temporary," he said, citing lower exports, a cut in inventory investment and declining defence spending.

Housing Remains a Risk

He acknowledged housing remained a risk to growth and that recent data signalled it would be a drag over coming quarters.

But Kroszner specifically countered fears that problems in the subprime mortgage market for borrowers with tainted credit, where defaults have soared and dozens of lenders have gone out of business, would seriously hurt the economy.

"Although developments in non-prime mortgage market are causing hardship for many individuals and families, to date these challenges do not appear to be having a broad impact on economic activity," he said.

On the other hand, the prospects for business investment had brightened and U.S. consumer spending should get support from a firm jobs market, and could even turn out to be stronger than expected.

"My view, and it seems the view of many private forecasters, is that economic growth will pick up as we move through the year, with the rate of expansion close to potential by 2008," Kroszner said.

He also explored the risks to inflation, including concerns that a deterioration in U.S. productivity growth could add to price pressures, if it turns out that this signals a lasting fall in U.S. efficiency.

"The possibility of a slowing in trend productivity is a risk to the outlook that I will continue to monitor," he said.

Tight labor markets were another inflation worry, although Kroszner played this down and said the current high profit margins of U.S. companies meant they could absorb rising unit labor costs "at least for a while."

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