Lockhart Favors Current Fed Rate, Sees Debate About an Increase

By Steve Matthews and Kathleen Hays

Aug. 16 (Bloomberg) -- Federal Reserve Bank of Atlanta President Dennis Lockhart said he prefers to keep interest rates unchanged for now, while anticipating a debate among policy makers about whether to raise them in coming months.

``From my perspective, I like policy where it is,'' Lockhart, 61, said in an interview with Bloomberg News yesterday in Atlanta. ``I view the current situation as reasonably balanced, with a great deal of uncertainty around both the downsides to growth and the upsides to inflation.''

The economy's expansion is likely to remain ``weak'' through the second half of this year, which should help to damp inflation, said the Atlanta Fed chief, who will vote on rates next year. That means ``the reasonable policy debate will be around holding versus raising rates,'' he said.

``If the inflation numbers remain high -- which is another way of saying if I'm wrong -- then I may support action earlier,'' Lockhart said. He said he is ``quite comfortable with the current posture'' as long as price gains moderate.

Lockhart's remarks followed a government report Aug. 14 that showed consumer prices jumped by the most since 1991 in the year to July, spurred by energy costs. He said ``all'' Fed officials are concerned about the ``creeping'' up in prices, while the slide in oil in the past month will help ease the pressure.

Energy Costs

``Certainly, it helps a great deal,'' the bank president said. ``The outlook for the second half of the year and going into 2009 is we'll see some alleviation of inflation pressures. Having oil and other commodities come down so strongly helps.''

The Fed kept its benchmark interest rate at 2 percent for the second straight meeting on Aug. 5. It paused after the most aggressive series of rate reductions in two decades this year. The odds of no change in rates through the end of the year are 77 percent, up from 49 percent a month ago, futures contracts show.

The Federal Open Market Committee, which is made up of the Washington-based Fed board members and five district bank presidents, next gathers Sept. 16. Four of the bank chiefs rotate onto the panel, with the New York Fed president holding a permanent slot.

``I would not rule out any action'' on rates, said Lockhart, who joined the Atlanta Fed last year and previously worked at Citigroup Inc. for 17 years. ``I think we have to react to circumstances.''

Inflation Expectations

The Atlanta Fed president said he was carefully watching inflation expectations, which have shown a ``slight upward drift'' yet are ``still anchored.''

One measure of investors' expectations for consumer prices shows they anticipate average increases of 2.19 percent in the coming 10 years. That's the spread between yields on 10-year Treasury Inflation Protected Securities and regular 10-year Treasuries. Lockhart said he prefers inflation at 1.5 percent to 2 percent.

Lockhart also said that the housing slump is likely to last at least several more months, with prices and sales continuing to fall. He expressed concern about the impact on growth of the tightening of access to credit as banks struggle to improve asset quality.

``The housing market still has some way to go,'' he said, calling inventories excessive. ``We see relatively few signs that house prices have bottomed out'' nationwide, he said.

Economists forecast the Commerce Department will report next week that U.S. housing starts fell to the lowest level since 1991 in July. The collapse in residential construction has subtracted from gross domestic product growth for the past 10 straight quarters.

Export Impact

With export growth helping, the U.S. economy seems likely to avoid an outright contraction this year, Lockhart added. While some forecasters see the likelihood of growth near zero in the fourth quarter, Lockhart said he doesn't expect anything ``close'' to negative. Still, he also said a global slowdown means exports are likely to slow.

Lockhart added that financial turmoil isn't likely to abate in the near future.

``Banks are tightening their standards,'' he said. ``I perceive a caution'' about bankers lending to consumers, especially with employment weakening, he said.

``I would characterize today's markets as still showing some stress,'' he said. ``Credit spreads have been somewhat rising.''

Values of some mortgage-backed securities continue to be hurt by falling home prices, Lockhart said. ``Those securities continue to be a source of problems for financial institutions.''

Loan Survey

The Fed said Aug. 11 in a quarterly survey that more banks made it harder to borrow money for homes, small businesses and credit cards. About 75 percent of U.S. banks indicated they tightened standards on prime mortgage loans, up from 60 percent in the previous survey, the central bank said.

``The healing process of the financial sector is going to take some time,'' Lockhart said. While financial institutions have reported more than $500 billion in losses and writedowns, ``I think it is reasonable to assume there will be some more pain before we really completely see a turn,'' he said.

To contact the reporters on this story: Steve Matthews in Atlanta at smatthews@bloomberg.net; Kathleen Hays in Seattle at khays$@bloomberg.net