1st Boston sees upturn in Europe; Japanese slide expected to go on.

SINGAPORE -- While U.S. monetary authorities are trying to decelerate the pace of their economy, the Japanese economy has yet to hit rock bottom and the yen is likely to weaken, senior economists of CS First Boston Ltd. said last week.

But they see a European recovery under way, induced by declining inflation and cuts in fiscal deficits.

Neal Soss, managing director and chief economist of CS First Boston in New York, said the Federal Reserve is concerned that the maturing U.S. business expansion is rapidly using up the economy's margin of spare resources, leading to possible inflationary flare-ups.

Speaking at a conference on the global economic outlook, Mr. Soss said the Fed was tilting away from "an expansionary or accommodative monetary stance" to relieve inflationary risks:

He said there was a broad consensus that potential U.S. gross domestic product growth without stirring inflationary pressures was about a real 2.5% per year.

The Fed with the acquiescence of President Bill Clinton's administration, was pursuing a policy of decelerating the growth rate by raising interest rates, he said.

CS First Boston expects the federal funds rate to rise by another 125 basis points, to about 5.5%, over the next nine to 12 months, before U.S. monetary policy officials would be persuaded that the economy had decelerated to the desired 2.5% growth path, Soss said.

Higher interest rates are likely to lead to more foreign exchange market interventions by central hanks and the strengthening of the dollar. If the dollar did not go up, it would be difficult to restore stability in U.S. financial markets, he said.

"If the real policy goal is a deceleration in the rate of economic growth, then the proximate goal must be a cyclical bear market in bond and stock prices," Mr. Soss said.

Susumu Kato, a CS First Boston managing director and the chief economist in Japan, said Japan's industrial production would hit rock bottom in the next three to six months. "We cannot expect any sustainable increase in industrial production over the long term because we have unutilized capacity of 30% in the manufacturing sector," he said.

The Japanese economy would grow by less than 1% this year and possibly slightly above 1% next year, Mr. Kato said. In the short term, the yen would weaken to trade at 110-112 against the dollar but recover to 104-105 long-term, he said.

Giles Keating, a company managing director and the chief economist in the United Kingdom, said the European recovery was finally under way. "The inflation outlook is good- but not quite as good as it seemed late last year.

Side Effects in Europe

"Fiscal deficits are too high and foreign demand for European bonds has dried up," Mr. Keating said. Short-term interest rates had virtually stopped falling, and the Bundesbank's repo rate would not go below about 5% this year, he said.

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