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Fed says US economy still in good shape

Victoria Thieberger in New York

Policymakers at the Federal Reserve said on Tuesday that the low level of interest rates is supporting US economic growth, and the risk of falling back into recession is slim.

In comments that suggested little urgency to cut interest rates further from current four-decade lows, Fed Governor Ben Bernanke said the economy was in good shape and unlikely to succumb to deflation, when prices decline across the economy.

His remarks were echoed by Minneapolis Fed President Gary Stern, who said the risk of the world's largest economy dipping back into recession was "relatively low," and economic growth would pick up from its current 3.0 per cent pace by the second half of next year.

Both Stern and Bernanke are voting members of the Fed's policy-setting committee, which decided last month to keep the federal funds rate steady at 1.75 per cent, where it has been for nearly a year.

"I think the risks of deflation in the US economy are extremely remote. The economy is in very good shape," Bernanke said in New York after giving his first major speech since being sworn in as a Fed governor in August.

"The recovery is proceeding but it's not as strong as we hoped or possibly expected some months ago," he added, noting the caution caused by overseas political developments.

"The issue is to what extent the slowness is due to geopolitical concerns and other issues that are essentially out of the control of the Federal Reserve, and to what extent there remains residual weakness," Bernanke said.

He echoed several other senior Fed officials in recent weeks by saying monetary policy was "accommodative", or supporting economic growth.

Rates are not the problem

The comments by the Fed officials had little impact on financial markets fixated on a surging stock market that led to the biggest one-day spike in Treasury bond yields since Oct. 1998. The price action further scaled back market bets that the Fed would cut interest before year's end.

However, economists on Wall Street are divided over whether the sluggish recovery will require more stimulus from the Fed, which meets twice more before the end of the year.

Although the economy is still expanding, businesses have been reluctant to invest in new projects or hire workers, and there are worries that free-spending consumers may start to flag. Adding to the general sense of uncertainty is the prospect of a possible US attack on Iraq.

Minneapolis Fed President Stern -- one of the longest-serving regional presidents -- said the US economy had weathered many external and internal shocks through the 1980s and 1990s, and stressed it was resilient enough to overcome most obstacles.

"I don't see it undermined by developments in the economic arena," said Stern, in his first public remarks in May.

But he did concede there were "a lot" of potential risks to the outlook, including geopolitical threats such as terror attacks and a US-led assault on Iraq.

Another Fed official, Atlanta Fed President Jack Guynn, said on Tuesday interest rates were not the problem for businesses at present, suggesting he sees little need for lower rates. Instead, businesses have been preoccupied by accounting worries, a tough pricing environment and geopolitical risks.

"My conversations with business people suggests to me that their decisions to spend have nothing to do with interest rates," said Guynn, who is not a voting member on Fed policy.

The reluctance of businesses to invest or hire has been a particular concern for Fed officials, who have said a pickup in capital spending is crucial to ensure a sustainable recovery.

The theme was echoed by Bernanke in comments to reporters.

"I think we won't be confident that the recovery is well on track until we see a resurgence of hiring and investment by firms. Firms are the laggards at this point," Bernanke said.

Employment fell by 43,000 in September, even though the unemployment rate also edged down, and jobs growth has been anemic all year. Worries about job security, recent stock market losses and the possibility of war have dampened consumer confidence recently, clouding the outlook for spending.

The Fed's policy committee meets next on Nov. 6.

Bernanke said in his speech the US central bank should keep its sights squarely on the economy and not use monetary policy as a tool to deflate potential asset bubbles.

"First, the Fed cannot reliably identify bubbles in asset prices. Second, even if it could identify bubbles, monetary policy is far too blunt a tool for effective use against them," he argued, stepping into a debate that has been raging since the US stock market began its long slide in March 2000. His views dovetailed with those of Fed Chairman Alan Greenspan.

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