July 6 (Bloomberg) -- Federal Reserve Bank of San Francisco President Janet Yellen said keeping interest rates unchanged is the best way to achieve faster growth and slower inflation in the U.S. economy.

``The virtues of this path are that it avoids exposing the economy to unnecessary risk of a downturn while, at the same time, it is likely to produce enough slack in goods and labor markets to relieve inflationary pressures,'' Yellen said in a speech via satellite to a conference in Singapore.

Yellen's remarks reflect the Fed's decision last week to hold its benchmark rate at 5.25 percent, where it has been for a year, amid signs of stronger growth and easing price pressure. Policy makers reiterated that inflation remains their ``predominant'' concern.

``An `asymmetric policy tilt' seems appropriate given the upside risks to inflation,'' Yellen said today. ``However, it is also essential that policy retain considerable flexibility in responding to emerging data.''

Latest indicators on the economy have been ``robust,'' including ``steadily'' increasing payrolls, she said. Housing markets are likely to be less of a damper on growth in coming quarters, though consumer spending increases will likely ``diminish'' and exports provide less of a stimulus, she said.

Yellen, 60, dropped a reference to a slump in business spending as a threat to the outlook, which she flagged in her April 26 speech on the economy in New York.

New Risk

Today, she noted a new risk, stemming from the recent financial-market volatility. The San Francisco Fed president, a former Fed Board governor and chairman of the Council of Economic Advisers under President Bill Clinton, noted increased premiums on debt backed by subprime mortgages.

Surging defaults on subprime loans, made to borrowers with poor or patchy credit history, led two Bear Stearns Cos. hedge funds to the brink of collapse last month. New York-based Bear Stearns was forced to put up $1.6 billion to rescue one of them, which lost money betting on mortgage bonds and collateralized debt obligations. CDOs are mortgages packaged together into securities that are sold to investors.

Commenting generally on increased premiums on riskier assets, Yellen said ``such developments are worth watching with some care, since there is always the possibility that they do presage a more general and pronounced shift in risk perceptions.'' She added that a reversal in those perceptions ``could pose a downside threat to the global economy.''

Overseas, low borrowing costs have attracted money into investment strategies such as ``carry trades,'' which expose investors to ``substantial exchange-rate risk'' that they may be underestimating, Yellen said.

Treasury Yields

The San Francisco Fed chief, who doesn't vote on rates on the Fed's Open Market Committee this year, was less concerned about higher yields on U.S. Treasury securities. The yield on the benchmark 10-year note rose to 5.18 percent at 8:32 a.m. in New York, up 4 basis points from yesterday.

``The markets and the committee have become more closely aligned, sharing the view that growth in the U.S. is, and is likely to remain, healthy,'' Yellen said.

The U.S. economy expanded at an annual pace of 0.7 percent in the first quarter, the slowest in four years. Economists surveyed by Bloomberg News anticipate the pace will quicken toward 3 percent in the second half.

U.S. growth should remain moderate for the rest of this year, picking up to a rate ``just below potential,'' Yellen said. Many economists have estimated the potential rate to be about 3 percent.

Inflation Rate

The Fed's preferred inflation measure, the personal consumption expenditures price index minus food and energy, slowed to a 1.9 percent rate in May, from 2.4 percent in February, a level that matched a four-year high.

While predicting further improvements in inflation, Yellen said one of the ``significant'' risks to that outlook is the possibility that productivity growth has slowed. Low unemployment is also a risk, she said.

The Labor Department reported today that the unemployment rate stayed at 4.5 percent in June. Employers added 132,000 new workers.

``I believe it is important to be particularly attentive to these risks not only because price stability is desirable in its own right, but also because a credible commitment to keeping inflation low and stable is necessary to ensure that inflation expectations remain well-anchored,'' she said.

Yellen doesn't become a voting member of the FOMC again until 2009. She is the only U.S. central banker scheduled to speak today.

To contact the reporter on this story: Vivien Lou Chen in San Francisco at vchen1@bloomberg.net.

Last Updated: July 6, 2007 08:34 EDT