Fed says plan now to avert inflation

By Ros Krasny

TULSA, Oklahoma (Reuters) - The United States economy will skid more deeply into recession in coming months, Federal Reserve policy-makers warned on Thursday, but it is time to start planning how to wind down spending to avert an inflationary surge.

The president of the Kansas City Federal Reserve Bank, Thomas Hoenig, said that hard as it was to predict when the winding-down process must be initiated, it will happen.

"We know it has to happen, but the timing I can't tell you. Nobody knows. We will watch every indicator of data that suggests a recovery is on the way," Hoenig said in response to audience questions after a speech in Tulsa, Oklahoma.

"Failure to do that at the right time means you risk a much higher inflation environment," he added.

Hoenig acknowledged the economy remains "under significant stress" from the ongoing banking crisis. But he said the U.S. central bank cannot wait until it is well into recovery and the job market is strong before acting.

The Fed's second longest-serving policy-maker added that he expects resistance "almost immediately" to any move to raise interest rates or, for example, to start selling off its stash of mortgage-backed securities.

Hoenig and a second regional Fed bank president, Gary Stern of Minneapolis, said there were still significant credit strains holding the economy back and cautioned that an eventual rebound likely will be mild.

"The recession is likely to persist for some time longer, and the initial stage of the recovery seems likely to be subdued," Stern said in remarks prepared for the South Dakota economic summit in Sioux Falls.