LOST PINES, Texas – The U.S. economy faces difficult challenges during a time of extraordinary turbulence, and weak growth will probably linger into 2009, a top Federal Reserve official said Monday, adding that the central bank needs to continuously re-evaluate its policies.

Charles Evans, president of the Chicago Federal Reserve, said risk evaluations reflect “substantial uncertainty in the outlook for both growth and inflation.”

In remarks prepared for an Association for Manufacturing Technology meeting in Lost Pines, Texas, Evans said core inflation, at 2.6 percent in the year through August, was “too high” and that even as commodity prices fall far off their peak there was still a chance high inflation expectations could become embedded in price- and wage-setting behavior.

Still, he said increasing slack in the economy would probably reduce more general cost and inflationary pressures, adding: “This channel seems stronger today than I expected earlier this summer.”

Evans said real economy activity in the United States would stay sluggish into the new year and that the level of uncertainty about the timing of a pickup in growth, which will depend on improvements in the financial and credit markets, “is very high.”

Evans is not a voting member of the Federal Open Market Committee in 2008 but will vote on interest rate changes in 2009.

Since the Fed's most recent policy meeting in September, conditions in money markets have taken a turn for the worse as banks have become more reluctant to lend to each other and wade into the murky waters of counterparty risk.

“This cascading re-pricing process has had a significant impact on liquidity and capital positions in a wide range of financial institutions,” Evans said.

Among the “many examples” of spillover from the financial turmoil to the nonfinancial economy ... there is a great deal of uncertainty over how the intensified stress in financial markets we have seen over the past few weeks – and the policy responses to them – will play out over time and how in turn this path will affect the economy,” he said.

Beyond the financial markets, Evans said the U.S. economy continues to be dragged down by protracted weakness in housing and elevated prices for energy and other commodities that have reduced the ability of households and businesses to spend.

Evans did not specifically address the Fed's next move on the fed funds rate, its primary tool of monetary policy. Financial markets are increasingly convinced that the Fed will lower the rate to 1.5 percent this month, at or before its regularly scheduled meeting on Oct. 28-29.

In making its policy moves, including the Fed's string of recent measures to support the flow of liquidity through the financial system, “we have been guided by our mandate to help foster a sound and stable financial system,” Evans said.