Fed's Mester says keep up the 'gradual' pace on rate hikes

[WASHINGTON] Federal Reserve Bank of Cleveland President Loretta Mester urged her colleagues to look past recent weak inflation data and to stick to their gradual pace of lifting interest rates, with one more increase projected before the end of this year.

"There's some risk that if we wait too long we can find ourselves in a bad spot," Ms Mester said in interview with Michael McKee on Bloomberg Television recorded on Saturday on the sidelines of the Fed's annual retreat in Jackson Hole, Wyoming.

"We have to move policy a little bit before we get to the goals or else we're going to get behind."

Ms Mester also said she favours beginning the run-down of the central bank's US$4.5 trillion balance sheet "soon".

Economists expect the Fed to make an announcement on the timing of that process after their Sept 19-20 meeting in Washington.

Fed officials are grappling with a recent spate of low inflation readings from an economy that otherwise looks healthy. Soft price data have caused some to wonder whether another rate increase this year will be appropriate.

The Fed has hiked its benchmark rate by a quarter-percentage point three times since mid-December, following a sustained decline in US unemployment that is expected to lift wages and inflation.

"We've had a couple of weak inflation reports lately, but you can point to some one-off factors," she said.

"I do expect inflation to remain below 2 per cent over the next couple of months or so, in the near term, and then eventually to rise up to our 2 per cent goal."

She'd be more concerned, she added, if the low inflation readings were the result of dropping aggregate demand, a factor that could also push down inflation expectations.

"That would be a significant factor," she said.

"But I don't see that in the data."

Ms Mester said companies in the Cleveland district, which includes Ohio, western Pennsylvania and eastern Kentucky, were reporting wages on the rise, "albeit gradually".

At the same conference where Fed Chair Janet Yellen warned against rolling back the post-crisis framework of financial regulation, Ms Mester said the potential for financial instability "loomed large", especially with interest rates remaining low.

She noted that some equity prices seemed high by historical standards.

"Right now I don't think that's a significant risk, but I'm certainly taking that into account," she said.

"That's another factor that feeds into my view that a gradual reduction of accommodation is appropriate for the economy right now."

Ms Mester said she didn't anticipate any disruption of bond markets when the Fed begins letting Treasury and mortgage-backed securities roll off its balance sheet.

"There'll probably be some reaction in the long rate, but I think it will be swamped by other things that would affect financial markets," she said.

BLOOMBERG