Wednesday, December 19, 2007

Fed's Lacker Sees `Very Weak' Growth Into Next Year (Update4)

By Craig Torres and Steve Matthews

Dec. 19 (Bloomberg) -- Federal Reserve Bank of Richmond President Jeffrey Lacker said economic growth will be ``very weak'' into next year as the housing market is set to keep contracting.

``I expect growth to be very weak for several more months,'' Lacker said in remarks at the Charlotte Chamber of Commerce's Annual Economic Outlook conference in North Carolina. ``Most cogent risks to the outlook are on the downside.''

Fed officials are trying to cushion the economy from the worst housing recession in 16 years. The Federal Open Market Committee has cut its benchmark interest rate 1 percentage point in the past three months to 4.25 percent, the biggest reduction in that period of time since the last recession in 2001.

``For now I am comfortable with what we have done,'' Lacker said when asked by reporters about policy decisions. ``We take it a meeting at a time and we will see how the data unfolds.''

Lacker still forecasts growth of 2 percent to 2.25 percent for next year, as consumer spending and exports offset the drag from housing.

``Home construction and sales are unlikely to bottom out before the middle of the year, and I expect housing to continue to be a drag on growth well into 2008,'' he said. Rising incomes, buttressed by job growth, ``will support further gains in consumer spending,'' he said.

Growth Forecast

Growth will probably slow this quarter to a 1 percent annual rate from a 4.9 percent pace in July to September, Lacker said. Fed officials predicted last month the expansion will slow to as little as 1.8 percent by the end of next year.

The Richmond Fed president, 52, next votes on interest rates in 2009. He alone dissented in favor of raising rates in the last four Fed meetings of 2006. Policy makers lowered the benchmark to 4.25 percent this month.

Lacker spoke on a panel with Kenneth Lewis, chairman and chief executive officer of Bank of America Corp., Ken Thompson, chairman of Wachovia Corp., and James Rogers, chairman of Duke Energy Corp. All three corporations are based in Charlotte.

Lewis forecast the economy to expand 1.5 percent to 2 percent next year. Thompson predicted growth of 2.2 percent in 2008, and told Lacker he expects ``several more fed funds cuts,'' with the rate ending 2008 at 3.75 percent or 4 percent.

Rogers said the economy ``will flirt with a recession all of next year,'' yet still avoid one. ``We will have slower growth, it will be good growth, and we will not be in a recession at the end of 2008 or 2009.''

`Uncomfortable' Inflation

Lacker said he is ``uncomfortable'' with the inflation outlook and ``disappointed'' that the improvement seen earlier this year ``was not more lasting.'' He told reporters after the speech that a ``drift up in inflation expectations'' is contributing to his concern.

The central bank's preferred inflation gauge, the personal consumption expenditures price index, minus food and energy, has risen at an annual rate of less than 2 percent since June. Still, the Fed in its Dec. 11 statement said that higher energy and commodity prices ``may put upward pressure on inflation.''

The Richmond Fed chief noted that the headline PCE index rose at a 3.3 percent annual rate in September and October, and said prices in November ``will be even worse.''

``Because the job of a central banker is to protect the purchasing power of currency, it is overall inflation that we need to keep down, not just core inflation,'' Lacker said. ``If energy prices fail to decline, monetary-policy decisions will be that much more difficult in 2008.''

A wave of foreclosures threatens to deepen the housing recession next year as the charges on subprime adjustable-rate mortgages reset higher.

Fed Proposals

Subprime mortgages are usually made to people with poor or incomplete credit histories. Subprime delinquency rates reached 16.3 percent in the third quarter, from 14.8 percent the previous three months.

The Bush administration this month negotiated an agreement with mortgage lenders to freeze some subprime home loans for five years, in an effort to forestall foreclosures.

The Fed's Board of Governors unanimously voted in favor of stricter regulations on high-cost mortgage lending yesterday. The proposal will ban most prepayment penalties and no- documentation loans, force high-cost lenders to escrow tax and insurance payments for at least a year, and make lenders accountable for the loan's affordability.

Fed Plan

The proposal, which received a mixed reaction in Congress and among consumer groups, will be subject to a three-month comment period before it is finalized.

Lacker called the rules ``strong measures'' that will ``substantially improve protections available to U.S. consumers.'' He said tighter restrictions ``are not without costs'' and may reduce the availability of mortgage credit for some consumers.

Rising mortgage delinquencies caused a reassessment of the value of derivative securities tied to mortgage bonds. Lower home prices and more defaults also diminished investor demand for mortgage debt, forcing banks to hold the assets.

Concerns about counter-party risk have made funding more costly in the interbank funding market, Lacker said.

On Dec. 12, the Fed, the European Central Bank and three other central banks moved in concert to alleviate the credit squeeze, making as much as $64 billion available to banks. The Fed published the results of its first auction for term funds today. The results showed 93 banks put in $61.5 billion in bids for $20 billion in funds, a sign of strong demand for the funds.

Financial markets are ``a significant source of uncertainty right now,'' Lacker said. He later told reporters that officials need to be ``careful'' because ``a lot can happen in markets that doesn't spill over'' into the ``real'' economy.

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