Fed's Kroszner Says `Rough Patch' Won't Warrant Cuts (Update5)

By Scott Lanman and Anthony Massucci


Nov. 16 (Bloomberg) -- Federal Reserve Governor Randall Kroszner said policy makers probably won't need to reduce interest rates further to help the economy weather a ``rough patch'' in the coming year.

``The current stance of monetary policy should help the economy get through the rough patch during the next year, with growth then likely to return to its longer-run sustainable rate,'' Kroszner said today in a speech in New York. Data consistent with such growth ``would not, by themselves, suggest to me that the current stance of monetary policy is inappropriate.''

The comments represent the most explicit message from a Fed policy maker since the Oct. 31 rate cut that the central bank is reluctant to lower borrowing costs further. The view among officials is in conflict with investor expectations, as futures prices on the Chicago Board of Trade suggest an 84 percent chance of a quarter-point cut at the Dec. 11 meeting.

``What you got from Kroszner is clearly a message that he's not thinking the way we are,'' said JPMorgan Chase & Co. chief economist Bruce Kasman, who yesterday forecast a rate cut next month, altering his prediction. ``Our best guess is that they'll make a change and ease, but I think it's a very close call.''

`Irrelevant' Data

Federal Reserve Bank of St. Louis President William Poole, in an interview with Dow Jones, said figures on economic growth in the fourth quarter will be ``irrelevant'' to next month's decision unless they offer indications for next year. Poole voted in favor of last month's rate cut.

Separately, Atlanta Fed President Dennis Lockhart said in an interview with Bloomberg that the U.S. slowdown this quarter may persist into next year and that officials will ``take very seriously anecdotal information'' from contacts.

``The downside risks to economic growth now appear to be roughly balanced by the upside risks to inflation,'' Kroszner said, echoing the Federal Open Market Committee's Oct. 31 statement. ``I would add that the limited data and information received since the October FOMC meeting have not changed my thinking in this regard.''

Kroszner, 45, serves as the Fed board's chief liaison with banks on regulatory matters. He previously taught money and banking at the University of Chicago for 16 years and worked as an adviser to the Fed and other central banks and finance ministries. Kroszner also served as a member of President George W. Bush's Council of Economic Advisers from 2001 to 2003.

Kroszner's Fed term ends Jan. 31, and his nomination for a full 14-year term is pending in the Senate.

Production Drops

Figures published by the Fed today suggested that the biggest housing slump in 16 years may be taking a toll on industrial production. Factories, mines and utilities reported a 0.5 percent decline in output, the biggest since January.

Last month's quarter-point cut in the overnight interbank lending rate to 4.5 percent followed a half-point reduction on Sept. 18. Both moves were ``governed in part by an attempt to manage the macroeconomic `tail risks' facing the U.S. economy,'' Kroszner said in prepared remarks to an Institute of International Finance conference on markets and regulation.

Financial-market strains ``contributed significantly to those macroeconomic risks,'' he said. Yet additional rate cuts would probably be less effective in mitigating such risks, said Kroszner, who has voted with the majority in every rate decision since joining the Fed in March 2006.

The U.S. economy, the world's largest, expanded at a 3.9 percent annual pace in the third quarter, the second straight period of growth near 4 percent. Economists expect the rate to slow to 1.5 percent in the three months ending December, the median forecast from a Bloomberg News survey.

Goldman's Warning

The credit collapse that began in August is likely to force banks, brokerages and hedge funds to cut lending by $2 trillion, risking a ``substantial recession'' in the U.S., Goldman Sachs Group Inc. economist Jan Hatzius wrote in a report dated yesterday.

Yesterday, the Labor Department said consumer prices rose 3.5 percent in October from a year earlier, the biggest 12-month increase since August 2006. Excluding food and energy, the gain was 2.2 percent, a half-percentage point slower than a year ago and a sign that ``core'' inflation is moving in a ``more favorable direction,'' Kroszner said.

``One feature of monetary policy to keep in mind is that, all else equal, each successive action in the same direction tends to lower the incremental benefits and to raise the incremental costs of additional actions,'' Kroszner said.

He also reiterated points from Chairman Ben S. Bernanke's Nov. 8 congressional testimony, including that the economy will expand at a ``noticeably slower'' pace.

`Well Anchored'

The Fed governor said that against the ``backdrop'' of rising energy costs, ``inflation expectations have remained reasonably well anchored.'' At the same time, rising oil and commodity costs are ``a source of major uncertainty for the overall inflation outlook,'' he said.

Crude oil futures rose to a record $98.62 on Nov. 7. The price of regular gasoline at the pump exceeded $3 a gallon this month for the first time since July, according to AAA.

Answering an audience question Kroszner said the ``costs in terms of potential for greater inflation, or a moving up in inflation expectations, are lower in an environment where inflation, particularly the core inflation numbers, are coming down.''

Yield Difference

Gauges watched by the Fed show investors anticipate faster price increases now than three months ago. Expectations, as measured by the difference in yields between 10-year Treasuries and notes indexed to inflation, have risen. The spread reached 2.44 percentage points Nov. 6, the widest since June.

In general, rate cuts may raise ``incremental costs in terms of the potential for inflation to increase,'' Kroszner said.

The Fed on Nov. 20 will release the first expanded economic forecasts under an overhaul announced this week. The central bank is shifting to quarterly from semiannual projections, extending them to a third year and adding predictions of inflation including food and energy costs.

Kroszner, in his remarks, said the new communication plan is an ``important advance'' that will help the public better understand the Fed's outlook and interest-rate decisions.