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Fed official sees modest '96 growth

WASHINGTON: The U.S. economy looks set to enjoy moderate growth this year, but the recent run-up in long-term interest rates raises questions about the outlook for 1997, Federal Reserve Governor Janet Yellen said Friday.

She told Reuters in an interview she expects the economy to grow at about 2 percent or slightly better this year, with stable inflation.

"I see moderate growth," she said. "To me, at this stage, the risks to the economy are roughly symmetrical."

Yellen's comments suggest that she likely would be content to hold rates steady at the Fed's next meeting on May 21, but that she might be willing to consider cutting them later this year if economic growth looks likely to stumble in 1997.

Long-term rates on everything from home mortgages to corporate bonds have risen sharply in recent weeks as hopes for a balanced budget deal have faded and fears of higher inflation have intensified.

Yellen said she had been surprised by how much rates had risen and made clear that she felt that the financial markets' fear of an upward price spiral was not justified.

"They have gone from over-emphasising the odds of a recession to over-emphasising the possibility of an inflationary spiral," Yellen said.

She played down the importance of recent rises in food and energy costs, saying the former is unlikely to have an impact on long-term inflation and calling the latter temporary.

Whether or not it is justified, however, the increase in long-term rates is likely to hurt interest-sensitive sectors of the economy like housing next year.

"The market has just put its foot on the brake," Yellen said. "We've seen a big enough increase in market rates that with a lag we should expect some negative effects."

She said it was an "open question" as to whether that posed a risk to the Fed's efforts to keep the economy on track for continued moderate growth next year.

"The market reaction is more than I would have expected," the central bank policymaker said. "It's an open question whether or not that poses a risk."

For this year, Yellen sees final demand growing moderately enough to keep the economy expanding at its long-term trend rate of about 2 percent or slightly better.

She said annualized growth in the second quarter might be above trend, as General Motors Corp. rebuilds car inventories after last month's strike.

But she made clear that she saw no signs that the economy was about to take off, raising the threat of an inflationary spiral and pushing the Fed to raise interest rates.

"I don't see on the demand side any forces that are obviously going to put us in the kind of situation we were in 1994, where demand was growing unsustainably and had to be restrained," Yellen said.

The central bank raised interest rates repeatedly in 1994 as it successfully sought to contain inflation.-Reuter