The U.S. economy has embarked on a period of sustained expansion and the Federal Reserve should continue to raise interest rates toward neutrality at a measured pace, Fed Bank of Philadelphia President Anthony Santomero said on Tuesday.
In a speech to the Philadelphia Chamber of Commerce, Santomero gave an upbeat outlook for the economy, predicting GDP growth of 3.5 percent to 4.0 percent in 2005 and employment growth of 150,000 to 200,000 a month.
He expected inflation to remain well contained this year, both by overall and core measures, though there was a risk unit labor costs could rise as productivity slowed.
"If the economy evolves as I expect over the next year or so -- with continued output growth, steady increases in employment, and reasonably low inflation -- then I expect we will continue to move the federal funds rate toward neutrality at a measured pace," said Santomero.
The Fed has raised interest rates five times since last May, taking the funds rate to 2.25 percent from 1.0 percent. Futures markets have also priced in another hike at the Fed's February meeting and see rate around 3.0 percent by mid-year.
Santomero added that the precise course the Fed takes very much depends on how the economy develops. "As I have said before, if signs of price pressure emerge on a consistent basis, we will need to consider quickening the pace at which we move toward policy neutrality," Santomero said.
Santomero noted that a widening trade deficit had sapped growth in demand for domestic production. A strong dollar and a relatively strong U.S. economy initially drove the gap, but the dollar had turned lower in recent years.
"The declining value of the dollar, combined with reasonable growth in the economies of our trading partners, should help stabilize our net export position in 2005," he said.
"As the trade deficit stabilizes, solid growth in spending by U.S. consumers and businesses should translate directly into solid growth in GDP," said Santomero.
However, he warned that the decline in the value of the dollar may lessen the competitive pressure on domestic producers that has until now limited their pricing power, thus adding to inflationary pressures.