Fed should raise rates to 1 percent: Hoenig

Kansas City Federal Reserve President Thomas Hoenig speaks in Atlanta, January 5, 2010.

BARTLESVILLE, Oklahoma (Reuters) - A top Federal Reserve official on Thursday made a bold call for the U.S. central bank to raise its key interest rate to 1 percent by the end of summer, saying the economy is strong enough to support such a hike.

Thomas Hoenig, president of the Kansas City Federal Reserve Bank, has called for a modest increase in borrowing costs before, but he went further on Thursday by before, but he went further on Thursday by suggesting it should happen over the next several months and by calling for an increase in borrowing costs to 3 percent in rapid order.

Hoenig, who is known as one of the Fed's most strident anti-inflation hawks, said the U.S. central bank should raise its benchmark federal funds rates to avoid being slow in responding to the recovery.

"Based on the current outlook consensus, it seems reasonable that the economy would be well-positioned to accept this modest increase in the funds rate," Hoenig told a business lunch.

The Fed cut interest rates to near zero percent in December 2008 and has kept them there since to aid economic recovery.

Hoenig said the recovery is gaining steam and appears stronger and more broad-based than anticipated.

"We are now seeing clear signs that the process of job creation is taking hold," he said.

Hoenig is a voter on the Fed's policy-setting panel and has dissented against the Fed's exceptionally easy money policies at all three meetings this year. He has said he is worried that rock-bottom borrowing costs for such a long period will fuel another dangerous boom-and-bust cycle.

Hoenig said on Thursday the Fed should start by dropping its promise to hold rates exceptionally low for an extended period, as part of the process of bringing interest rates and the Fed's extension of credit to the economy back to normal.

The U.S. central bank should then raise rates to 1 percent and then stop while it assesses how the economy reacts to the higher rates. If the recovery remains solid, the Fed should push borrowing costs to 3 percent reasonably quickly, he said.

The Fed should also sell some of the mortgage-backed securities it bought as it sought to give the flagging economy an additional boost after it chopped interest rates to near zero, he added.

The debt crisis in Europe is "fluid" and poses a risk to the recovery, Hoenig said.

(Reporting by Mark Felsenthal, Editing by Leslie Adler)