By Mark Felsenthal
WASHINGTON (Reuters) - Most Federal Reserve officials prefer to raise rock-bottom interest rates before selling assets when the time comes to tighten policy, restoring their main tool for managing the economy, according to minutes of their April meeting.
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The minutes, released on Wednesday, also showed worries about inflation rising among Fed officials last month before a big surge in oil prices subsided.
During an extensive discussion of how the central bank might pull back its massive support for the world's largest economy, officials indicated unloading the mortgage debt the Fed piled on during the financial crisis would be a priority in eventually shrinking the Fed's $2.7 trillion balance sheet.
"A majority of participants preferred that sales of (mortgage) agency securities come after the first increase in the (Fed's) target for short-term interest rates," the Fed said.
"Many of those participants also expressed a preference that the sales proceed relatively gradually, returning (Fed holdings) to all Treasury securities over perhaps five years," the minutes said.
Policymakers felt that holding off on asset sales would allow them to get their target for overnight rates up from its current level near zero sooner than otherwise, the minutes showed. Fed officials have long felt discomfort that their main policy tool was essentially exhausted.
The U.S. central bank chopped rates to near zero in December 2008 and then pumped $1.4 trillion into the economy through purchases of mortgage and government debt.
In November, it launched a fresh program to buy $600 billion more of government bonds in an effort to keep borrowing costs down and spur a stronger recovery.
Now, its eyes are turning toward an eventual unwinding of its unprecedented stimulus and the minutes underscored that there would have to be a big threat to the recovery to spur a fresh round of asset purchases.
At the same time, however, the minutes stressed that the April discussion did not indicate the Fed was ready to start tightening policy any time soon.
INFLATION WORRIES UP WITH OIL
While policymakers generally believed a recent rise in inflation would be transitory, many had become more concerned about upside price risks. A few felt the Fed should stand ready to tighten policy sooner than had been expected.
The suggestion the day of the Fed's first tightening move could come sooner than thought caused long-term bond prices to slip and strengthened the dollar against the euro and the yen. Stocks, however, held earlier gains.
Policymakers worried that if oil prices continued to rise it could spill over into a wider range of prices. They also worried a self-fulfilling inflationary mind-set could take hold. Oil prices have dropped sharply since the meeting.
When the Fed concluded its two-day meeting on April 27, it signaled it was in no hurry to reduce its economic supports.
"It is a relatively slow recovery," Fed Chairman Ben Bernanke told reporters just hours after the meeting ended.
"The combination of high unemployment, high gas prices and high foreclosure rates is a terrible combination. A lot of people are having a tough time," he said.
Some officials since the meeting have called for the Fed to quickly reverse course from its ultra-easy money policies. Others have made clear depressed jobs and housing markets continue to justify loose monetary policy.
U.S. inflation hit a 2-1/2 year high in April, but energy prices were largely to blame.
Policymakers have said that with core inflation measures not far from historical lows, there is plenty of room to boost growth without igniting a broader pick-up in prices.
But officials say they are watching closely to make sure higher gasoline and food prices do not spur a troubling rise in inflation expectations.
Since the meeting, economic data have underscored the unevenness of the economic recovery.
U.S. companies created jobs at the fastest pace in five years last month, although the unemployment rate edged up to 9 percent, while retail sales posted their smallest rise in nine months in April and factory activity cooled.
(Reporting by Mark Felsenthal; Editing by Neil Stempleman)