By Steven K. Beckner

(MNI) – New York Federal Reserve Bank President William Dudley
downplayed inflation risks Friday and said stronger economic growth and
job creation are not cause for the Fed to “reverse course” on its
accommodative monetary policies.

Speaking just four days before the Fed’s policymaking Federal Open
Market Committee meets to reassess the outlook and reconsider interest
rates and asset purchases, Dudley said the Fed should not “overreact” to
surging commodity prices.

And the FOMC vice chairman, after cheering February’s 192,000
non-farm payroll gain, said that even if payrolls rise at a rate of
300,000 per month, “considerable slack” would remain in the labor market
at the end of next year.

Dudley said he expects such slack to continue to “dampen price
pressures in the near term” in remarks prepared for delivery to the
Queens Chamber of Commerce and Queens Economic Development Corporation
in Flushing, N.Y. He was careful to add that the Fed must keep an eye on
inflation, as well as potential financial “excesses” and protect “price
stability” over the longer run.

His comments strongly suggest that he does not feel the need to
move away from the Fed’s zero federal funds rate policy or stop
expanding the Fed’s balance sheet anytime soon.

Most of Dudley’s comments had a familiar ring, but he took fresh
note of the latest jobs figures, reported last Friday by the Labor
Department. Aside from the sizable payroll gain, they showed a further
one-tenth drop in the unemployment rate to 8.9%.

Dudley said “last Friday’s report helps resolve some conflicting
signals,” observing that previous reports had shown unemployment falling
but only “very modest” payroll gains.

“Particularly encouraging is the growth of manufacturing jobs,” he
said. “Over the past year we have added factory jobs at the fastest pace
since the 1990s. This makes me more confident that job growth in January
was temporarily depressed by unusually bad winter weather.”

Dudley noted that “other labor market indicators, such as initial
claims for unemployment insurance benefits and the employment components
of both manufacturing and nonmanufacturing business surveys have also
shown improvement recently.”

He predicted “job growth will increase considerably more rapidly in
the coming months,” but he said that is something to be welcomed, not
feared.

“A substantial pickup is sorely needed,” he said. “Even if we were
to generate growth of 300,000 jobs per month, we would still likely have
considerable slack in the labor market at the end of 2012.”

Echoing Fed Chairman Ben Bernanke, Dudley said “the economic
outlook has improved considerably in the past six months,” but added “we
are still very far away from achieving our dual mandate of maximum
sustainable employment and price stability.”

“Faster progress toward these objectives would be very welcome,”
Dudley said.

In Congressional testimony last week, Bernanke said the FOMC will
need to “think in advance” about when to tighten policy and said, “Once
we see the economy is in a self-sustaining recovery and employment is
beginning to improve and labor markets improving and meanwhile that
inflation is stable, approaching roughly 2% or so, which is where we
want to be in the long term on inflation, at that point we’ll need to
begin withdrawing.”

But Dudley suggested the FOMC should be in no hurry to tighten in
the face of a strengthening economy.

“A stronger recovery with more rapid progress toward our dual
mandate objectives is what we have been seeking,” he said. “This is
welcome and not a reason to reverse course.”

Although the economy “may be much closer to establishing a virtuous
circle that will support stronger growth,” Dudley cautioned, “we must
not be overly optimistic about the growth outlook.”

“The coast is not completely clear,” he continued. “The healing
process in the aftermath of the crisis takes time and there are still
several areas of vulnerability and weakness.”

He noted that housing activity remains “unusually weak” and that
“state and local government finances remain under stress, and this is
likely to lead to further spending cuts, tax increases, or job losses in
this sector that will offset at least a part of the federal fiscal
stimulus.”

What’s more, “we cannot rule out the possibility of further shocks
from abroad,” he warned, noting that already “higher oil prices cut into
household purchasing power, and the situation in the Middle East and
Africa remains uncertain and dynamic.”

The U.S. fiscal mess also presents challenges, he said.

Against that backdrop, mounting fears of inflation and/or financial
imbalances are overblown in Dudley’s view.

He said the Fed must “remain watchful for signs that low interest
rates could foster a buildup of financial excesses or bubbles that might
pose a medium-term risk to both full employment and price stability.”
But he said “current risk spreads on U.S. financial assets are not
unduly compressed,” suggesting that “people are still being relatively
cautious about taking on a lot of financial asset risk.”

As for inflation, he said “there are some signs that core inflation
is now stabilizing after falling for several years,” but said “both
headline and core inflation remain below levels consistent with our dual
mandate objectives,” which he defined as “2% or a bit less” using the
personal consumption expenditures (PCE) index.

Dudley said “the large amount of slack in the economy has
contributed to declining inflation over the past couple of years,” and
he said, “I expect this slack to continue to dampen price pressures in
the near term.”

Moreover, “inflation expectations are well-anchored today and we
intend to keep it that way,” he said, adding, “A sustained rise in
medium-term inflation expectations would represent a threat to our price
stability mandate and would not be tolerated.”

Dudley said Fed policymakers “always need to be careful about
inflation — even in an environment of ample spare capacity,” especially
since oil and other commodity prices are surging. But he went on to
minimize the inflationary threat posed by commodity prices.

He cited three reasons why “it would be unwise for the Federal
Reserve to over-react to recent commodity price pressures by raising
interest rates soon:”

– First, despite the general uptrend, some of the recent commodity
price pressures are likely to be temporary;

– Second, Dudley said even if commodity price pressures were to
prove persistent, they have a smaller impact in the United States than
they do in many other countries;

– Third, he said the Federal Reserve’s success in anchoring
inflation expectations has also been important in limiting pass-through.

“Thus, while rising commodity prices may be giving some of you a
bad headache, they are not likely to lead to a sustained rise in
inflation to levels inconsistent with our dual mandate,” Dudley said.

Swinging back to a more cautious tone again, Dudley added, “We will
have to ensure, however, that these pressures do not cause inflation
expectations to become unanchored. If that were to occur, that would be
a troublesome development that would complicate the pursuit of our dual
mandate of high employment and low and stable inflation.”

** Market News International **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,MT$$$$,M$$BR$]