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Fed's Mester sees downside risk from escalating trade war

By Ann Saphir and Howard Schneider

By Ann Saphir and Howard Schneider

JACKSON HOLE, Wyo., Aug 24 (Reuters) - Cleveland Federal Reserve President Loretta Mester said on Saturday she sees "big downside risk" from rising trade uncertainty, and will be watching how businesses and consumers react ahead of the U.S. central bank's next policy meeting.

Mester, who opposed the Fed's interest rate cut last month, spoke a day after the U.S.-China trade war escalated sharply, with Beijing and Washington slapping additional tariffs on each other's goods and President Donald Trump calling on U.S. companies to exit China.

Whether trade and other policy moves will knock a U.S. economy chugging along at an expected 2% annual growth rate remains to be seen, Mester told Reuters on the sidelines of the Fed's annual central banking conference in Jackson Hole, Wyoming.

Mester said she and her team of economists at the Cleveland Fed are still formulating their forecasts ahead of the central bank's Sept. 17-18 meeting, at which it is widely expected to reduce borrowing costs for the second time this year.

"You want to be very cognizant of the fact that we are already at neutral, unless the economy takes a turn for the worse," Mester said, referring to the neutral rate of interest that neither brakes nor boosts a healthy economy.

She added that "the more this trade war escalation happens, the more weight you have to put on that other (weak growth) scenario."

If there’s a lot of uncertainty, particularly from trade, "a natural inclination for business or the consumer is, 'I’ve got to like, pause,'” she said. "I think that is a big downside risk here."

On Friday, Fed Chair Jerome Powell cited the trade uncertainty in a keynote speech to the conference in which he reiterated his promise that the Fed would "act as appropriate" to keep the economy growing, with unemployment low and inflation near the central bank's 2% annual target.

He did not tip his hand on whether he thought rate cuts at the Fed's next policy meetings would be appropriate, as financial markets are currently betting.

Mester said she would be "open-minded" on the rate-cut debate, focusing on "economic and financial market reconnaissance" including a close look at what business contacts are saying and doing.

"We have three weeks: We're going to gather more data, we are going to look at what the economy is," she said, adding that she'll be focused on whether declines in business sentiment are translating into real actions that slow the economy.

"If you were ever data-dependent, you are uber data-dependent now," she said. "It would be a bad thing to keep reacting to things that haven't materially affected the outlook."

On the other hand, she added, "if your outlook has changed from, the modal forecast is 2% to the modal forecast is much lower, you'd want to move, perhaps, your policy rate down." (Reporting by Ann Saphir Editing by Paul Simao)