Wed Aug 25, 2004
By Alister Bull

ATLANTA, Aug 25 (Reuters) - A recent soft spot in U.S. growth will likely prove temporary and should not alter a Federal Reserve plan to gradually raise interest rates, Atlanta Fed Bank President Jack Guynn said on Wednesday.

He said record high oil prices were one reason behind the economy's recent hesitation and offered reassurance that the Fed has the flexibility to respond to shocks in either prices or growth.

"The data and anecdotal reports we have at this time continue to suggest we can work our way toward a more neutral interest rate setting in a 'measured' way," he told the TAPPI Decorative and Industrial Laminates Symposium in Atlanta.

Guynn stressed the Fed was not raising rates because it felt growth was running too fast, but rather because the economy no longer needed the same level of monetary stimulus.

The benchmark federal funds rate stands at 1.5 percent after the Fed raised rates by a quarter percentage point at each of its last two policy meetings. However, U.S. growth has unexpectedly faltered in recent weeks, leading some analysts to ask whether the Fed would take a break from tightening.

U.S. gross domestic product growth slowed in the second quarter to 3.0 percent from 4.5 percent in the prior three months after a sharp slowdown in consumer spending in part from a jump in gasoline prices.

And with oil prices powering to record highs just below $50 a barrel last week, some economists are concerned about third-quarter growth as well.

"In light of recent reports, I would concede that it's fair to question what's ahead. You might ask if the economy is getting bogged down for an extended stretch of eroding growth. Or are we just going through another brief soft patch on our way to sustainable recovery?" Guynn said.

TEMPORARY ALARM

Guynn's view was that businesses and consumers had been temporarily alarmed by rising oil prices and the threat of terror attacks, while some shoppers had decided to stay home and watch the Olympics, which end this weekend.

As a result, Guynn felt the pause would prove fleeting and the "likelihood of solid and sustainable growth looks good".

He later amplified on this, telling reporters: "I don't think (the oil price rise) has been debilitating at this point ... We will work our way through this as we have before."

But he stressed the Fed was not focused on inflation to the exclusion of what was happening in the real economy.

"It's important to keep in mind that we can all be surprised by output and price developments as they unfold, and as our June and August statements noted, the FOMC (Federal Open Market Committee) has the flexibility and 'will respond to changes in economic prospects as needed'".

He also said the U.S. economy's stumble would lead to slightly slower growth in the second half than he had expected earlier.

"I have not lowered my third-quarter and fourth-quarter GDP estimates by any huge amount," he told reporters, declining to detail the Atlanta Fed's new forecast.

Guynn also acknowledged that recent inflation numbers signaled price pressures may be starting to ease after a run-up in inflation earlier in the year. But Guynn stressed he was not yet satisfied the inflation danger had passed.

"I continue to be struck by the extent of cost pass-through. In fields where demand is strong and growing, we are seeing price increases beginning to stick," he said.

On the other hand, he saw no evidence that oil prices had yet made their way into future inflation expectations.

"I don't get the impression that the run up in oil prices has got permanently embedded into the price structure," he told reporters.

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