Hoenig says Fed must eventually raise rates

OKLAHOMA CITY, Oklahoma (Reuters) - Interest rates cannot remain at their current rock-bottom lows indefinitely, particularly as the economy recovers, Kansas City Federal Reserve Bank President Thomas Hoenig said on Thursday.

Hoenig grabbed the spotlight last week by dissenting from the Federal Reserve's vow to keep interest rates near zero for an "extended period", sparking some speculation that the central bank was moving closer to an eventual rate hike.

Speaking to a bankers' conference, Hoenig said he expects the U.S. economy to grow just over 3 percent this year, which he said will eventually warrant pushing borrowing costs toward more normal levels.

"What's normal is very difficult to know, but I know one thing, it's not zero," Hoenig said.

To that end, he reiterated his desire to see the Fed remove language from its policy statement signaling to markets that they can count on low rates for a long time.

"I did not dissent on interest rates, I dissent on the language," Hoenig said. "That's the kind of language I would use in the crisis. But we've moved through the crisis."

U.S. gross domestic product surged 5.7 percent in the fourth quarter, but few analysts expect that impressive pace to be sustained. Hoenig noted that after some retrenchment, consumer confidence -- and spending -- appeared to be making a gradual comeback.

In an effort to fend off the worst financial crisis since the Great Depression, the Fed not only slashed interest rates to their current zero to 0.25 percent range, but also undertook a host of unconventional measures to revive lending.

Hoenig said that despite the successes of ultra-loose monetary and fiscal policy at returning the economy to a growth path, the key policy challenge of removing this stimulus in a timely manner still lay ahead.

He argued that there was a natural tendency in financial markets to want the central bank to offer ever increasing amounts of liquidity, but that it was up to policy-makers to resist such pressures.

The remarks stood in contrast to those of New York Fed President William Dudley. In an interview with the Associated Press, Dudley would not rule out further purchases of mortgage securities if "there's a sharp turn in the road."

"Nothing is on automatic pilot," Dudley said.

Both officials highlighted ongoing risks to the Fed's independence.

In particular, Hoenig said a rising U.S. budget deficit would boost political pressure on the Fed to keep rates low in order not to push up government financing costs.

He reiterated a frequent call for resolving the problem of financial institutions that are deemed too large to fail, stating that if those firms were forced to operate without implicit government backing they would not have taken such huge risks.

"When you have real interest rates pressures begin to mount, there is inevitably a desire to have the central bank hold them down," he said.