Weak U.S. prices, not inflation, the threat now: Fed's Yellen

By Jonathan Spicer NEW YORK (Reuters) - Persistently low inflation poses a more immediate threat to the U.S. economy than rising prices, Federal Reserve Chair Janet Yellen said on Wednesday, stressing that the U.S. central bank would be delivering policy stimulus for some time to come. In her second public speech since taking the Fed's helm, Yellen was careful not to predict when interest rates would rise from near zero. Instead, she stressed the decision would hinge on healing in the labor market and on how briskly inflation rises toward the Fed's 2 percent goal. Yellen's relatively staid remarks to the Economic Club of New York intensified somewhat when Martin Feldstein, a Harvard University professor and former adviser to President Ronald Reagan, asked her whether she would let inflation creep above 2 percent to give the economy a bit more support. "With inflation running at around 1 percent, at this point I think the risk is greater that we should be worried about inflation undershooting our goal and getting inflation back up to 2 percent," Yellen said. The central bank will "of course" eventually need to tighten policy to avoid a run-up in inflation, she said. "Overshooting that goal ... can be very costly to reverse." Yellen noted the Fed was not alone in its struggle to move inflation higher as a buffer against an economically disabling deflation. The European Central Bank is mulling unconventional policies that could lift inflation in the euro zone, while Japan has been mired in deflation for 15 years. The Fed has kept its key rate near zero since the depths of the financial crisis in late 2008, and has bought more than $3 trillion in assets to help depress borrowing costs and stimulate economic growth amid a frustratingly slow recovery. While the central bank's preferred inflation gauge is just above 1 percent, a more popular measure firmed in March. Jobs growth was also decent last month, but the unemployment rate stayed high at 6.7 percent as Americans returned to the labor market in droves to search for work. U.S. stocks added to gains on Yellen's remarks, which investors viewed as underscoring the Fed's willingness to be patient in nursing the economy back to full health. "This concern about the persistent weakness in inflation provides the key justification for the Fed to remain cautious about tightening policy prematurely or too aggressively," said Millan Mulraine, deputy chief economist at TD Securities. VAGUE ROAD MAP FOR WALL STREET An apparent pick up in the world's largest economy after a sluggish winter has many investors attempting to predict when the Fed will finally raise rates, with most eying mid-2015. Yellen herself said it was "quite plausible" the economy would be back to near full employment and a healthier level of inflation by the end of 2016. "We are seeing very meaningful progress, although clearly ... the goal has not been achieved at this point," she said. "We will be very focused on removing accommodation when the right time has come." In the last few years, the Fed has tried an array of strategies to telegraph just how long it will wait to tighten policy, including tying the ultra-low rates to time periods, and later, to specific unemployment and inflation thresholds. Last month it rolled out its latest version of forward guidance, effectively promising not to raise rates for a "considerable time" after it halts its bond-buying program. But Yellen sowed more confusion when she then told a news conference that a "considerable time" means about "six months" or so, causing a selloff in stocks and bonds. Yellen did not mention the six-month term on Wednesday. How long rates will stay near zero, she said, will depend on how far the U.S. economy remains from the central bank's goals of 2 percent inflation and maximum sustainable employment, and how long it will likely take to meet them. She repeated her view that there is likely more slack in the labor market than suggested by the unemployment rate, which lessens the risk of inflationary wage gains as the economy strengthens. But she emphasized that unforeseeable events could alter the central bank's current course, as it has several times since the economy began recovering from the 2007-2009 recession. The Fed could even set aside efforts to wind down its bond-buying stimulus if dealt an economic surprise, Yellen said. Financial markets believe the Fed is nearly certain to end its purchases by year end. (Reporting by Jonathan Spicer; Additional reporting by Ann Saphir and Krista Hughes; Editing by Chizu Nomiyama, Andrea Ricci and Chris Reese)