October 5, 2017 / 4:20 PM / a year ago

UPDATE 1-Fed's Williams: Low growth, low rates, likely here to stay

(Adds comments on inflation, rate outlook)

By Howard Schneider

ST. LOUIS, Oct 5 (Reuters) - The long-term trend in annual U.S. economic growth may be as low as 1.5 percent, San Francisco Federal Reserve President John Williams said on Thursday, a somber view that implies perpetually low interest rates and a difficult hurdle for the Trump administration’s promised economic surge.

Williams said that unless tax and other policies are structured carefully to boost the economy’s potential, not just feed short-term spending and demand, the risk would be “imbalances” like asset bubbles and high inflation.

“We are trying to keep this economic expansion on a sustainable footing for as long as possible,” Williams told reporters on the sidelines of a community banking conference here.

The Trump administration has said its plans will raise growth to 3 percent, a target many economists say is unrealistic unless the population grows faster, naturally or through immigration, or productivity improves for existing workers.

Williams’ prepared remarks to community bankers and state bank supervisors came as a warning of sorts, that the higher interest rates and wider spreads that previously supported bank profitability likely won’t return.

“Like the pager, the Walkman, and the Macarena, we’re unlikely to see such rates return. Bottom line: In the new world of moderate economic growth, banks need to plan for lower rates,” Williams said in a spate of pop-culture references dating to the 1990s, when interest rates were higher but beginning a long slide.

Williams said the Fed does need to continue raising short-term rates, with unemployment low and a conviction on his part that a recent lull in inflation will prove temporary. Williams said he does not need to see inflation itself improve to support another rate hike this year, as long as other data answer the question of whether the economy continues to grow.

“Is the story holding together?” he said.

Long-term rates should rise as well as the central bank reduces its long-term asset holdings, he said.

But the long run will look different, he said, as demographic trends, weak productivity, and an aging population likely suppress potential economic growth throughout the developed world. His estimate that “trend growth,” after accounting for inflation, is only 1.5 percent, puts him as the most pessimistic among policymakers whose range of long-run growth projections runs from 1.5 percent to 2.2 percent.

Lower growth, in turn, will hold down the “neutral” federal funds rate to around 2.5 percent, around two percentage points below historical norms and a level the Fed could reach next year or early in 2019.

The neutral rate serves as a rough reference point for where the current round of interest rate increases may stop. In addition, Williams said banks should prepare for rates across the yield curve to be suppressed, with the spread between the federal funds rate and the 10-year Treasury note likely stuck at around 1 percent compared to 1.5 percent historically.

“Banks, and everyone else, need to prepare accordingly,” for a world where global interest rates are permanently lower, he said. (Reporting by Howard Schneider; Editing by W Simon and Andrea Ricci)

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