Goldman's Cohen sees no Fed surprise

By Ros Krasny

NEW YORK (Reuters) - The Federal Reserve is within a meeting or two of being done with its program of rate increases and is unlikely to rattle the market with a surprise 50 basis point move, Goldman Sachs chief U.S. investment strategist Abby Joseph Cohen said on Wednesday.

"This is a Fed that has been very, very methodical ... Sixteen consecutive increases of 25 basis points. At this point they would not be inclined to go to 50," Cohen said at the Reuters Investment Outlook Summit in New York.

Fed funds futures fully price in a quarter-point rate hike at the June 28-29 Federal Open Market Committee meeting; the door to a half-point increase opened a crack after a surprisingly high May core consumer price index reading on Wednesday.

Core CPI, which excludes food and energy costs, has risen by 0.3 percent for the past three months, raising inflation alarm bells. Over the past 12 months core prices have risen 2.4 percent, marking the biggest gain since the period ended in February 2005.

Fed officials, from Chairman Ben Bernanke on down, have been hammering on the issue of keeping inflation and inflation expectations down for about two weeks. Minutes from the May FOMC meeting showed that a potential half-point rate increase was raised by at least one policy-maker.

"Just because they discuss it does not mean there will be an extremely high probability of it happening," Cohen said.

"At any point of inflection, there is an appropriate obligation (for policy-makers) to consider all options."

Sounding like the Fed economist she once was, Cohen noted that monetary policy acts with long and variable lags. "We have not seen the full impact of the previous rate hikes," she said. The Fed "is not trying to create a recession."

Goldman's forecast is for U.S. economic gross domestic product growth to slow to 2.5 percent, annualized, by the fourth quarter of 2006 from 5.3 percent in the first quarter. For the whole of 2006, real GDP growth should be 3.5 percent, similar to 2005.

"That's a sustainable level of growth that could continue for some time without a dramatic building in core inflation," Cohen said. "It is hard for us to come up with a really ugly inflation scenario."

She termed unit labor costs a key element of the inflation outlook and said that continued strong levels of productivity were holding down wage pressures -- although rising health care costs were a concern.

Meanwhile, the source of U.S. economic growth was said to be in the process of a "rotation" from consumers to businesses, and Cohen said U.S. exports could show more leadership because of gains in overseas economies.

One of the most surprising developments in recent years has been "that it has taken so long for the rest of the world to show improvement in economic activity," she said.

Cohen said the U.S. yield curve was not a good predictor

of the economy because of the much larger influence of foreign investment in U.S. Treasuries compared with the past.  Continued...