U.S. Economy Will Cool, But At Manageable Pace

Boston Fed chief says central bankers still need to keep eyes on inflation.

BOSTON (AP) - The U.S. economy should slow in coming months from roughly 4 percent growth to an expansion in the high 2 percent range, which should slowly ease inflationary pressures, Federal Reserve Bank of Boston President Cathy Minehan said Monday.

Still, she cautioned that inflation remains a risk, and that the Fed should remain ''quite vigilant'' in containing that risk.

''I see growth for the next year or so in the high 2's, approximately full employment, and core inflation subsiding,'' Minehan said in the text of remarks delivered to the National Association for Business Economics.

The U.S. economy grew at a 5.6 percent pace in the first quarter and 2.9 percent in the second.

''As near as we in Boston can tell, the best baseline forecast is that U.S. growth will moderate ... to something slightly below its potential of a bit less than 3 percent over the next year or so,'' Minehan said.

''At this pace, the growth of demand will roughly match that of aggregate supply, and lead to little change in unemployment,'' she added.

Minehan's forecast suggests that the central bank can continue to keep rates unchanged while it surveys the economic scene. The Fed last month kept the federal funds rate at 5.25 percent, the first pause since the Fed began its credit-tightening campaign in mid-2004. The Fed is widely expected to hold rates steady when it meets next week as well.

One ''obvious concern'' to the economic outlook, Minehan said, is housing. While she's ''comfortable'' with forecasts for a ''moderate downturn'' in residential building, Minehan cautioned that recent data, including ''gloomy assessments'' by home builders, ''remind me that this assessment could well be optimistic.''

''There are clear risks to the baseline housing outlook,'' she said, citing the effect of higher mortgage rates on borrowers, particularly sub-prime borrowers.

Yet Minehan pointed to the fact that home prices continue to grow, albeit at a ''much slower'' pace, as well as signs that home prices may not have as much of a ''wealth effect'' as once thought by some analysts. Those factors may limit any downside impact on consumer spending, which Minehan expects to ''moderate, not collapse.''

Meanwhile, ''solid'' global growth and robust U.S. productivity should support the expansion, as should business spending, she said.

Regarding inflation, the Boston Fed President, who isn't a voting member of the Fed's rate-setting board this year, called recent trends ''not very favorable.''

However, she said inflation expectations measures suggest financial markets agree with her baseline forecast that core inflation will ''gradually subside'' assuming stability in energy prices.

Still, ''a key risk is that inflation will continue to rise or persist at high levels and embed itself in consumer and business plans,'' Minehan said.

''Managing that risk is clearly important, and a matter about which central banks need to be quite vigilant _ as I believe the (Federal Open Market Committee) has been and will continue to be,'' she said.

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