By Yali N’Diaye

WASHINGTON (MNI) – While the road ahead is “bumpy” for the U.S.
economy, “we are still several notches above double dip recession,” San
Francisco Federal Reserve Bank Director of Research John Williams said
Wednesday.

In a speech prepared for delivery to a community leaders luncheon
in Portland, Oregon, Williams also ruled out deflation as “highly
unlikely.”

“I expect inflation to remain low, dipping to around 1%, but not
get stuck in negative deflationary territory,” he said.

Williams, who also is the San Francisco Fed’s executive vice
president, said the recovery is still on track, even if the pace has
become “more subdued.”

“The upward trend in spending and consumer confidence that had
appeared to be steadily building has dissipated,” he said.

He also noted that auto sales, which have reached a plateau, “are a
telling barometer of households’ reluctance to open their pocketbooks.”

He explained the weakening by the impact of the fiscal crisis in
Europe, stock market volatility as well as ongoing weakness in the labor
market and the housing sector.

In the housing sector, “new construction is nearly dormant,” he
said as a result of weak demand, and the situation for commercial real
estate is “even worse.”

Getting out of this rough spot will not be easy given that the
government stimulus will play a smaller role going forward and “state
and local government budgets across the country are under immense
strain.”

Spending in this sector represents 12% of the economy, and “won’t
contribute to economic recovery for some time,” he said.

Even so, Williams ruled out a double dip recession.

“Although discouraging, the recent softness in the economic data
looks much more like a bump in the road of what we already thought would
be a gradual recovery, rather than a swerve into the ditch,” Williams
said.

Abroad, he expects confidence to rebuild, albeit slowly, following
the European fiscal crisis due to the effective response from the
European governments and the International Monetary Fund.

The San Francisco Fed expects U.S. GDP growth to be 2.5% this year,
before rising to 3.5% to 4% in 2011, accompanied by “some job growth.”

Should his forecast materialize, it won’t be enough to bring down
unemployment in a significant way, he said.

“Unless the economy picks up faster than I expect, unemployment
will come down with agonizing slowness,” he said.

He said he expects the unemployment rate to be at 9.5% at the end
of the year — the same as it was at the end of June. And it is still
going to be as high as 8.5% at the end of 2011.

While such developments should keep inflation low, Williams does
not expect deflation to settle in. Nor does he see concerns about higher
inflation justified on the ground that the Fed’s quantitative easing
will eventually lead prices higher.

“Despite a more-than-doubling of the monetary base,” he said “M2
has risen only 11% over the past two years, significant, but hardly
alarming.”

Besides, wage and price data have rather reflected lower inflation
trends, with business ability to increase prices constrained by weak
demand.

“With the economy recovering slowly, I don’t see this picture
changing anytime soon,” he said.

“There is a small risk of deflation, especially if it takes longer
for the economy to recover than I expect,” he said. ” But I view a
sustained period of deflation as unlikely.”

He said price trends are not as sensitive to the state of the
economy as they were in the past. In addition, he said the public
anticipates the Fed will act appropriately to avoid deflation. So
“inflation expectations are well anchored.”

“What all of this means is that the economy is still on a recovery
path, with moderate growth, and that inflation will remain very low,”
he concluded. “But we face significant risks to this outlook and need to
remain vigilant.”

** Market News International Washington Bureau: 202-371-2121 **

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