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NEW YORK, May 20 (Reuters) - New York Federal Reserve President William Dudley said on Tuesday he expects inflation to drift higher over the remainder of the year, though "excess capacity" in the U.S. economy is helping to moderate price pressures.
Dudley's remarks come as the Fed grapples with several major issues, including when to raise interest rates, and when to start scaling back its more than $4 trillion balance sheet.
After more than five years of highly accommodative monetary policy, including near zero interest rates and bond purchases, the Fed is facing pressure from policy hawks to tighten and raise rates more quickly.
Dudley has tended to join Fed Chair Janet Yellen in a more dovish stance, a stance reflected in his remarks on Tuesday.
Speaking at an event in New York, Dudley said that while headwinds are growing less severe, the trajectory of economic growth continues to disappoint.
He also made a point to say that inflation is rising but not sharply, and that the Fed's 2 percent inflation target is not a ceiling.
"I would expect that we would spend as much time slightly above 2 percent as below it, recognizing that we will hardly ever be exactly at 2 percent because of the inherent volatility in prices," he said.
In 2011, the Fed outlined its so-called exit strategy in which halting reinvestments was the first step to shrinking its balance sheet, which now tops $4 trillion, down to a more normal size around $1 trillion. If the Fed sticks to a plan laid out in 2011, a decision to stop reinvesting bond proceeds from Treasuries and mortgage-backed securities would precede any increase in interest rates and mark the beginning of the Fed's first tightening cycle since 2004-2006.
Dudley on Tuesday said he supported the view that the Fed should delay ending its balance sheet reinvestments until after the central bank raises rates.
He noted that some economists have argued that the amount of slack in the labor market may be smaller than suggested by the official unemployment rate, as this crowd is focused on short-term unemployment rates as driving compensation trends.
Dudley took issue with this notion, a view held by Yellen, saying that in his own judgement, one should not jump to such a conclusion.
"Some of the factors holding down inflation...were one-offs and are now dropping out of the year-over-year figures," Dudley said at a lunch hosted by the New York Association for Business Economics. "In some other areas, such as owners' equivalent rent, price pressures look likely to firm somewhat." (Reporting by Michael Flaherty; Editing by Chizu Nomiyama)