- USA TRADERS THREAD -

DJ UPDATE: Richmond Fed's Lacker Sees '06 GDP Growth At 3.5%

(Updates with latest GDP data and Lacker's views on inflation targeting)

By Brian Blackstone
Of DOW JONES NEWSWIRES

WASHINGTON (Dow Jones)--Fundamentals for the U.S. economy appear sound heading into 2006, but the Federal Reserve must remain attentive to any deterioration in inflation expectations, Federal Reserve Bank of Richmond President Jeffrey Lacker said Wednesday.
"The overall outlook ... is for a healthy expansion next year," Lacker said in prepared remarks to the Charlotte (N.C.) Chamber of Commerce.
Lacker projected that gross domestic product will expand at about 3.5% in 2006, which is near what most economists consider its noninflationary limit.
The U.S. grew at a 4.1% annualized pace in the third quarter, the Commerce Department said Wednesday, and expanded by 3.3% in the second quarter.
But he cautioned that uncertainties remain on the inflation front, in particular whether steep energy price gains in recent months filter to non-energy-related prices.
"While the lack of an upsurge in the core (personal consumption expenditures) inflation figures for September and October is somewhat encouraging, I think it is too soon to declare that pass-through risk is entirely behind us," Lacker said.
Lacker said his remarks are consistent with the Federal Open Market Committee's Dec. 13 statement that "elevated energy prices have the potential to add to inflation pressures."
Noting that financial markets seem to expect core inflation will remain contained, Lacker said, "to maintain credibility for price stability, it is essential that monetary policy should respond vigorously to any visible erosion in inflation expectations."
Lacker is a non-voting member this year of the FOMC. The FOMC raised rates at each of its eight meetings in 2005, including its most recent on Dec. 13, and the fed funds rate now sits at 4.25%, its highest level since May 2001.
Lacker will be a voting member in 2006. The Fed is widely expected to raise the fed funds rate a 14th straight time to 4.5% at its next meeting on Jan. 31, which will be Fed Chairman Alan Greenspan's last meeting. The nominee to replace Greenspan, White House Chief Economist Ben Bernanke, is expected to be confirmed by the full Senate and take over on Feb. 1.
Like Bernanke, Lacker favors setting an explicit inflation target to guide policymakers. Currently, the Fed has a dual goal of price stability and maximum sustainable employment, but no set numeric target for price growth.
Lacker proposes setting a 1% to 2% target range for the core PCE price index, which excludes food and energy costs. That index, he noted, averaged 1.8% over the 12-month period ending in October.
Fed watchers are split on whether the central bank will continue raising rates after January or hold them steady, with incoming economic data, particularly on inflation, key to future rate moves.
Lacker also addressed one of the main wild cards for the U.S. economy heading into 2006: the housing market, which has been a key source of support of both consumption and employment in recent years.
"Mortgage rates are likely to stay somewhat above their recent lows in the coming year, so I would expect housing price appreciation to flatten out next year and aggregate residential investment to stop growing or perhaps even decline," the Richmond Fed president said.
However, "I do not think that a sharp fall in housing investment is likely," he added.
And any such softening in housing should be compensated for by robust business investment, which "should expand substantially faster than overall output," Lacker said, noting that fundamentals for spending on equipment and software "look quite sound."

-By Brian Blackstone; Dow Jones Newswires; 202-828-3397; brian.blackstone@dowjones.com