* Sees economic slack restraining inflation
* Wants to halt bond reinvestments after rate hike
* Stresses 2 percent inflation target not a cap
* Fed’s Plosser warns on inflation risks
By Michael Flaherty
NEW YORK, May 20 (Reuters) - The Federal Reserve should be able to raise interest rates slowly when it eventually tightens monetary policy given that slack in the U.S. economy is restraining inflation, a top official at the central bank said on Tuesday.
New York Federal Reserve President William Dudley said the economy was poised for stronger growth and inflation should “drift upwards” towards the Fed’s 2 percent goal. But a swift climb in inflation was unlikely, he said.
“My current thinking is that the pace of tightening will probably be relatively slow,” Dudley told a group of business economists in New York. He also reiterated that the central bank would wait a “considerable time” after winding down its bond-buying stimulus program before raising rates from near zero.
Philadelphia Fed President Charles Plosser offered a more hawkish view during a speech in Washington, warning that the central bank risked waiting too long for a rate hike.
“As we continue to move closer to our 2 percent inflation goal and the labor market improves, we must be prepared to adjust policy appropriately,” he said. “That may well require us to begin raising interest rates sooner rather than later.”
Both Plosser and Dudley have votes on the Fed’s policy-setting panel this year, but Dudley’s views are considered to be more in the mainstream of thinking at the central bank.
The Fed is grappling with several major issues, including when to raise interest rates and when to start scaling back its more than $4 trillion balance sheet.
In a signal of a shift in the thinking at the central bank, Dudley said the Fed should consider continuing to reinvest proceeds from the bonds it holds until after it raises rates.
Previously, the central bank had said letting the bonds roll off to shrink its balance sheet would likely come first, but Dudley said that could lead markets to believe a rate hike is coming sooner than the Fed might intend.
Dudley also suggested the Fed could rely heavily on a new tool - its so-called reverse repo facility - to help control rates when it does finally begin to tighten policy.
After more than five years of highly accommodative monetary policy, including near zero interest rates and massive bond purchases, the Fed is beginning to face pressure from so-called inflation hawks, such as Plosser, who are worried the central bank might unleash inflation.
Dudley signaled little concern, and said he would be as comfortable having inflation a bit above the Fed’s 2 percent target as below it.
“My own view is that 2 percent is definitely not a ceiling,” he said, adding that he would be more tolerant of inflation if unemployment remained well above the level the Fed views as consistent with full employment.
The core price index the Fed tracks most closely stood at just 1.2 percent in March, and while the jobless rate dropped sharply in April, at 6.3 percent it is still well above the 5.2 percent to 5.6 percent range most officials associate with full employment. (Editing by Chizu Nomiyama and Paul Simao)