By Brai Odion-Esene and Alyce Andres-Frantz

CHICAGO (MNI) – Chicago Federal Reserve Bank President Charles
Evans said Tuesday that while there is no spending pressure yet from the
increase in reserves at banks, leaving historically low interest rates
in place for too long would eventually build inflationary pressures.

He also said the impact of the European crisis on the U.S. will be
magnified if events in Europe accelerate to the point that “they have a
more severe and broad impact on financial markets.”

In a speech prepared for delivery to the University Club of
Chicago, Evans, a voter on the Federal Open Market Committee in 2011,
said he does not believe that inflation is about to explode, nor is he
concerned about deflation.

“I think inflation will remain relatively stable,” he said.

He noted that currently, most of the funds used to expand the Fed’s
balance sheet sit “idly” in bank reserves, meaning they are not yet
generating spending pressure.

“But, of course, leaving the current highly accommodative monetary
policy in place for too long would eventually fuel such inflationary
pressures,” he warned.

With core inflation currently at 1.25%, Evans said he sees resource
gaps and accommodative monetary policy roughly balancing out over the
medium-term. “As resource slack abates in a recovering economy, I expect
inflation to move up to about 1-3/4 percent by 2012.”

Monetary policy will eventually have to return to a normal stance,
he said, but acknowledged that judging the proper timing and pace at
which to tighten policy will pose a challenge for the Fed.

The Fed’s decisions will be based on careful monitoring of business
activity and looking for signs of changes in the inflation outlook, he
said.

“Overall, I am confident that monetary policy will both support
economic growth and bring and keep inflation near my guideline of 2
percent over the medium term,” Evans said.

Evans was upbeat on the U.S. economy, voicing his optimism that the
recovery will continue and forecast real GDP to grow about 3.5% this
year.

He added a note of caution, however, warning that “we still need to
experience a good deal of growth before we return to the more normal
pace of economic activity and levels of unemployment that we enjoyed in
late 2007.”

Evans noted that the recent growth seen in the U.S. economy is
being driven by more than just government stimulus. “Unmistakably,
private spending has been reviving,” he declared.

Both consumers and businesses are contributing, he continued,
pointing to increases in business spending on capital equipment and a
rise in personal expenditures in the first quarter of 2010.

On the downside, Evans said, “Fundamentally, supply conditions
continue to weigh on real estate markets, and they could for some time
as foreclosures add to the overhang of unsold homes.”

The labor market is another area where Evans sees sluggish
progress, predicting that the rate and length of unemployment will
improve “relatively slowly.”

He counseled against inferring too much about the state of the
economy from May’s jobs numbers, saying while they were disappointing,
“they are only one month’s numbers.”

Evans is confident that as the recovery progresses and businesses
become more confident in the future, employment will increase on a more
consistently solid basis.

“Indeed, there are signals that we currently are near such a
turning point,” he said.

Evans also expects conditions in the banking sector to improve and
support growth in the U.S., “but this is likely to take some time.”

Overall, he projected that the need for households to repair their
balance sheets will moderate growth in consumer spending going forward,
in addition to the already reduced availability of household credit and
the fact that muted gains in employment will hold back growth in wages
and salaries.

“All of these factors contribute to an outlook for relatively
modest growth in consumer spending, which, in turn, restrains the
forecast for overall GDP growth,” he said.

As has been the practice by Fed officials in recent weeks, Evans
concluded his remarks by commenting on the debt crisis in Europe,
assuring the gathering that there are few channels through which
European sovereign debt problems could influence the U.S.

Direct exposure to European debt is limited, he said, but one
knock-on effect could be a lowering of U.S. net exports — due to
reduced demand — which would in turn reduce the outlook for GDP.

However, the trade effects from Europe’s fiscal situation are
likely to be limited, Evans continued, but warned that things could get
more serious here if events in Europe evolve so that they have a more
severe and broad impact on financial markets.

“Then the scope of the problems for the U.S. could be magnified.”

** Market News International Chicago Bureau: 708-784-1849 **

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