Wednesday, August 20, 2008

Stern Says It's `Good Time to Be Patient' on Rates (Update1)

By Vivien Lou Chen and Kathleen Hays

Aug. 20 (Bloomberg) -- Federal Reserve Bank of Minneapolis President Gary Stern said an oil-price decline will probably push headline inflation lower, allowing the central bank to ``be patient'' in considering a change to the main interest rate.

``Now is a good time to be patient because I do think we will see better news on the inflation front,'' Stern said today in an interview from Minneapolis with Bloomberg Television.

Central bank policy makers signaled earlier this month that persistent financial market turmoil and falling employment would delay any increase in borrowing costs. The Federal Reserve kept its benchmark interest rate at 2 percent on Aug. 5, pausing for a second straight meeting.

A 22 percent drop in crude oil, from a record $147.27 a barrel on July 11, has ``certainly helped,'' said Stern, 63, the central bank's longest-serving policy maker and a voter on rates this year. ``The implication is not immediate, but over the next several months we should see a diminution in the rate of headline inflation,'' he said.

Traders are placing 77 percent odds of no change to the overnight lending rate between banks for the rest of the year.

A growing number of Fed bank presidents, while voicing concern about inflation, have said the central bank shouldn't wait for markets to settle before lifting rates.

`Completely Certain'

Dallas Fed President Richard Fisher said yesterday the central bank might ``have to move ahead of what everybody else perceives to be the turn.'' The Richmond Fed's Jeffrey Lacker said such an increase could come ``before we are certain all of the weakness is behind us and before we are completely certain that financial markets are as tranquil as we would like to see.''

Prices paid to U.S. producers rose twice as much as economists had forecast in July, according to figures released yesterday by the Labor Department. Consumer prices rose at the fastest pace in 17 years last month.

``We largely have addressed the potential downside risks from here,'' Stern said today. Still, the Fed will ``have to probably adopt a somewhat less accommodative monetary policy before it is altogether clear that robust growth has resumed. But that point is somewhere in the future.''

Referring to the ``dual mandate'' of the Fed to limit inflation while promoting maximum sustainable employment, Stern said, ``If you look at the performance of the economy vis-a-vis the dual mandate, we are achieving neither part of it at the moment.''

``Inflation is higher than certainly I would like it to be, and growth has been quite modest recently,'' he said.

Federal Support

Stern reiterated his view that federal support for Fannie Mae, Freddie Mac and Bear Stearns Cos. may prompt excessive risk-taking by bolstering investors' view that some firms are ``too big to fail.''

Still, ``you cannot deal with these problems in the middle of a lot of turmoil and turbulence and disturbance,'' he said. Actions to save Fannie Mae, Freddie Mac and Bear Stearns have been ``appropriate given the risks,'' he said.

The U.S. Treasury, in legislation aimed at restoring investor confidence, gained authority last month to inject capital into Fannie Mae and Freddie Mac. Stocks and bonds issued by the companies have since slumped.

Now ``would not be an appropriate time to close'' Fannie Mae or Freddie Mac, Stern said. The Fed will monitor banks' exposure to preferred shares of Fannie Mae and Freddie Mac, the largest sources of money for U.S. home loans, he added.

``But I don't think the problem with Fannie and Freddie is just confined to banks that happen to hold their preferred stock,'' Stern said. ``It is important Fannie and Freddie continue to function as effectively as possible under these circumstances.''

``Once we get through this period, as we certainly will, we want to sit down and take a look at what is the appropriate framework and the appropriate role for these institutions,'' he said.

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