The current level of U.S. prices is noticeably lower than what it would be if the Federal Reserve had delivered on its 2-percent inflation target, St. Louis Federal Reserve President James Bullard said, calling the trend "worrisome."
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In slides prepared for delivery in Tokyo on Friday, the U.S. central banker said U.S. prices are now 4.6 percent below the price level path established from 1995 to 2012, when inflation was growing near the Fed's target of 2 percent each year.
"This is not as severe as the 1990s Japanese experience, but it is worrisome," said Bullard, who does not vote on U.S. monetary policy this year.
Too-low inflation has kept the Fed from raising rates more than three times since the Great Recession, but since late last year most Fed policymakers have seen faster rate increases ahead, citing improvements in the labor market.
Bullard also said he sees minimal impact on long-term bond yields from reductions in the Fed's balance sheet, which he hopes will start in the second half of this year.
Bullard, speaking to reporters after the speech, said it was good to cap the amount of mortgage-backed securities and Treasuries that are allowed to run off the Fed's balance sheet. However, he was indifferent to what the size of the caps should be.
The Fed is monitoring subprime auto and student loans but they are not near danger levels, he added.
U.S unemployment registered 4.4 percent in April, below what Fed officials believe is a sustainable level. Most Fed officials expect to raise the target interest rate three times this year, including the increase they made after their March policy meeting
But Bullard said that a surge in inflation is unlikely even if unemployment falls further.
With inflation still below 2 percent and inflation expectations and Treasury yields falling since the Fed raised rates in March, the Fed's plans for rate increases may be "overly aggressive" he said.
The Fed is expected to raise rates at its June policy-setting meeting, and will release fresh economic projections at that time.
Bullard, who regards the economy as mired in a low-inflation, low-growth rut, has said he feels the central bank needs to raise rates only one more time and should then pause until it is clear the economy has shifted to a higher gear.
Bullard also told reporters the Bank of Japan must communicate carefully with markets if it decides to taper its purchases of Japanese government bonds, and that it would be prudent for the central bank to lay out an exit strategy.
"It's very important to get the communication right," Bullard said. "Otherwise there will be outsize reaction and cause a lot of global dislocation."
Japan's inflation is nowhere near the BOJ's 2 percent target, but analysts are growing concerned because the bank's balance sheet has swelled to 90 percent of the nation's nominal gross domestic product - triple the ratio for the European Central Bank and nearly four times that of the Fed.
(Writing by Ann Saphir; Additional reporting by Stanley White; Editing by Diane Craft & Shri Navaratnam)