Wed Jul 21, 2004

NEW YORK, July 21 (Reuters) - The U.S. economic expansion still has ample momentum and recent signs of softness should be transitory, Philadelphia Fed President Anthony Santomero said on Wednesday.

In remarks that closely echoed those of Fed Chairman Alan Greenspan in testimony to Congress on Tuesday, Santomero played down the soft economic figures for June, which included retail sales and employment.

"Some of the most recent data have been on the soft side, but I think this reflects the usual fits and starts in a dynamic economy, not a significant change for the broad outlook," Santomero said in prepared remarks to the Philadelphia Business Journal.

That suggests central bankers will continue on the path of gradual interest rate increases despite the recent soft patch of data, and indeed the Fed's official forecasts released on Tuesday implied growth will remain strong this year.

The Fed raised official interest rates in June to 1.25 percent, the first tightening in four years, as it starts to unwind its easy money policy of recent years that has fuelled the recovery.

Santomero, who is not a voting memeber of the Fed's policy committee this year, said he expected economic growth to run somewhat above its long-run potential and inflation to be reasonably slow and stable over the next year or so.

In such circumstances the Fed would continue to raise interest rates at a measured pace, he said.

But if the recent softness persisted and the expansion seemed to be faltering, then the Fed might have to consider slowing the pace of rate hikes, said Santomero.

But equally, if inflationary pressures seemed to be accumulating, the Fed would need to consider quickening the pace of tightening.

"If the economy evolves as I expect over the next year or so ... then I expect we will continue to move the federal funds rate up at a measured pace," the Philadelphia Fed chief said.

And such interest rate rises should not unduly disturb financial markets, he added, partly because the Fed is being clear about its intentions. The Fed's June rate increase was widely expected and barely caused a ripple in bond or stock markets.

"In any case, given the likely pace of these policy adjustments and the Fed's commitment to transparency and clear communication about them, I expect the financial markets will continue to take Fed actions in stride, adjusting asset values accordingly," Santomero said.

While the growing economy will inevitably create some inflationary pressures, the current cycle may generate less inflation than in the past, Santomero said.

He said unit labor costs bear close watching, but he noted the recent slowdown in labor costs had in part helped improved corprate profit margins.

"So as the process reverses, some of the acceleration in unit labor costs could come at the expense of those margins, rather than in the form of higher inflation."

The powerful forces of globalization and international competition could also limit price pressures in the United States, he said.

Santomero is the first of four Fed officials speaking on Wednesday, and their tone is expected to echo that of Greenspan, who gave an upbeat outlook on the economy to the Senate Banking committee on Tuesday.

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