Fed officials divided on policy outlook

By Ann Saphir

CHICAGO (Reuters) - Minneapolis Federal Reserve Bank President Narayana Kocherlakota on Wednesday repeated his call for an interest-rate hike by year's end, but comments from two other Fed policymakers suggested continued support for the Fed's easy money stance.

Kocherlakota, a voter this year on the Fed's policy-setting panel, said he sees core inflation rising by year's end to 1.5 percent, still short of the Fed's informal 2 percent target, but nearly double the rate last year.

If that forecast pans out, "The Fed would then be closer to its price stability mandate -- and so should ease the pressure on the monetary gas pedal," he said. "My recommendation in this scenario would be to raise the target fed funds rate by 50 basis points," he told the Forecasters' Club of New York.

But two other top Fed officials -- Cleveland Fed President Sandra Pianalto and Atlanta Fed President Dennis Lockhart -- said they expect inflation to recede and expressed concerns on the jobs front, suggesting little appetite for rate hikes any time soon.

U.S. payrolls rose by a more-than-expected 244,000 jobs last month, but first-quarter economic growth fell short of expectations, casting doubt on the strength of the recovery.

Lockhart said he would need to see several more months of job creation before the Fed could abandon its pledge to keep rates low for an extended period. Speaking in Atlanta, he said he would not anticipate when the process of unwinding Fed stimulus should begin, though the bar is very high for any further Fed policy easing.

The Fed has kept benchmark rates near zero since December 2008 and is on track to buy a total of $2.3 trillion in long-term securities by June to push borrowing costs down.

A Reuters poll found economists had raised forecasts for inflation this year but even so a vast majority of those polled expected the U.S. central bank to hold rates at the current level of near zero through 2011.

Futures traders also see no chance of a Fed rate hike this year, with short-term U.S. interest-rate contracts pricing in a 44 percent chance of a March 2012 rate hike and a 63 percent change of hike in April.

"I am encouraged by the fact that the economy is increasingly on firmer footing," Lockhart said in Atlanta. But he added: "The cadence of the recovery has been halting. At the gradual pace that I am expecting, it could take up to three years to get employment back to pre-recession levels."

Lockhart and Pianalto, who do not vote on Fed policy this year, argued that while higher prices for commodities and energy had pushed up U.S. consumer prices in the short run, their impact would likely be fleeting.

"I do not expect inflation to remain above 2 percent beyond this year," said Pianalto, speaking in Cincinnati.

The Cleveland Fed chief said she expects the recovery to continue at a gradual pace, just above an annualized pace of 3 percent, for the next few years. At that rate, unemployment would drop to its longer-run sustainable level of between 5.5 and 6 percent in about five years, she said.

The views of Pianalto and Lockhart appear to be more in step with the core of the policy-setting panel than those of Kocherlakota, who is among a handful of policymakers who have said higher rates may be warranted.

In April, Fed Chairman Ben Bernanke said the central bank is in no hurry to tighten policy given the state of the labor market.

Kocherlakota's call for a rate hike stands apart from those of his more hawkish colleagues because it is tied to a specific inflation forecast.

Should inflation rise faster than expected, to 1.8 percent this year, the Fed should raise rates more aggressively, he said. Should it fall relative to 2010, he said, further easing through asset purchases would be desirable.