Fed's Bullard says inflation expectations key

ST. LOUIS, Missouri Thu Apr 1, 2010 5:28pm EDT

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ST. LOUIS, Missouri (Reuters) - St. Louis Federal Reserve Bank President James Bullard said on Thursday the central bank would need to act quickly if markets began to expect sharply higher levels of inflation.

"You've got an extraordinary policy in place because of the large shock we've suffered," he told reporters. "It's possible that inflation expectations could start to move out of control, and I think if that (were to) happen, that would trump everything and the Fed would have to come in and take action."

Bullard, a voting member this year on the Fed's policy-setting panel, stressed he does not think inflation expectations are currently out of control or even likely to become so in the future.

The Fed held rates steady near zero at its March meeting and renewed a pledge to hold borrowing costs exceptionally low for an extended period to nurse the struggling economy back to health.

Officials cite a high unemployment rate as justifying the extended period pledge, but Bullard's remarks show other pressures could force the Fed to tighten financial conditions.

Bullard said he expects a report on Friday to show that employers added jobs in March.

"In general terms, the recovery is proceeding apace and labor markets will follow behind and will continue to improve, but we'd all like to see a positive number and we'd like to build on that going forward," he said.

However, he said that it would not be a sequence of positive jobs growth numbers alone that would prompt the Fed to drop its low-rate extended-period pledge. The U.S. central bank's next rate-setting meeting is at the end of the month.

"It depends on how the economy is looking going forward and we don't want to get ourselves in a box that we're going to take a particular action on a particular calendar date," he said.

It is welcome that jobless claims have drifted down, Bullard said, adding that housing data has been mixed in the December-February period but appear stable at a low level and unlikely to be a drag on growth.

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