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Fed’s George Sees 2% Growth as Housing Gain Counters Budget Cuts

May 10 (Bloomberg) -- Federal Reserve Bank of Kansas City President Esther George said the economy will probably grow 2 percent this year, spurred by Fed stimulus that threatens to eventually push up long-term inflation expectations.

A strengthening housing recovery is counteracting headwinds from a fiscal spending contraction that will probably crimp growth in the second and third quarters, George said today to the Wyoming Business Alliance in Jackson, Wyoming.

“Housing starts are coming back online and we are also seeing the demand for housing coming back,” while home prices “are beginning to firm,” said George, who holds a policy vote on the Federal Open Market Committee. “The employment picture is getting better,” with monthly payroll growth averaging 200,000 “a positive sign.”

George, 55, has dissented this year against FOMC decisions to press on with monthly purchases of $40 billion in mortgage-backed securities and $45 billion in Treasuries, saying the record stimulus may destabilize markets and impair employment.

“The economy is pushing against some headwinds coming from fiscal issues,” George said. “We have seen growth slow because of the sequestration.”

Federal budget cuts totaling $85 billion commenced on March 1 and will probably trim the nation’s gross domestic product by 0.6 percentage point this year, according to the Congressional Budget Office.

George said business owners have told her they’ve put hiring “on hold until they see clearly” the impact from the Affordable Care Act, which is expected to expand health coverage to about 27 million uninsured Americans.

Easing ‘Complications’

The so-called quantitative easing that has swollen the Fed balance sheet to $3.32 trillion may lead to “complications” as the central bank begins to exit the policy, George said. Risks include a jump in longer-term inflation expectations and a “painful adjustment” for investors when the benchmark interest rate is eventually raised, she said.

“Continuing this current policy outside of the crisis, outside of a recession, poses risks to us in the long term,” George said.

Low interest rates prompt investors to “reach for yield,” which may make them “particularly vulnerable to the point at which rates must rise,” George said. “That could require a painful adjustment that I worry about.”

The FOMC said last week it will continue buying bonds “until the outlook for the labor market has improved substantially.” It also left unchanged its statement that it plans to hold its target interest rate near zero as long as unemployment remains above 6.5 percent and the outlook for inflation doesn’t exceed 2.5 percent.

Jobless Rate

The unemployment rate decreased to 7.5 percent in April as employers added 165,000 workers to payrolls. Initial jobless claims fell by 4,000 to 323,000 in the week ended May 4, the fewest since January 2008, the Labor Department said yesterday. The four-week average declined to 336,750, the lowest since November 2007, the month before the start of the recession.

While the unemployment rate has moved toward the Fed’s goal of 5.2 percent to 6 percent during the past year, inflation has fallen further from the Fed’s long-run target of 2 percent. Inflation dropped to 1 percent from a year earlier in March, the slowest since 2009, according to the Fed’s preferred inflation gauge.

George, who became chief of the Kansas City Fed in 2011, was the Fed district bank’s No. 2 official under Thomas Hoenig, now vice chairman of the Federal Deposit Insurance Corp. She joined the Fed in 1982 and spent much of her career in bank supervision.

The Kansas City district represents Colorado, Kansas, Nebraska, Oklahoma, Wyoming, northern New Mexico and western Missouri.

To contact the reporter on this story: Jeff Kearns in Washington at jkearns3@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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