"Pretty high hurdle" to QE3: Fed's Bullard

President and CEO of the Federal Reserve Bank of St. Louis James Bullard poses during an interview at the Federal Reserve Bank of St. Louis June 8, 2011.

NEW YORK (Reuters) - Federal Reserve policymakers still see a "pretty high hurdle" before they would unleash a third round of quantitative easing, or QE3, a top Fed official said on Friday.

Speaking two days after the U.S. central bank decided to take a more modest policy step to help the flailing economic recovery, St. Louis Fed Bank President James Bullard said the Fed has done "what it can do."

"QE3 I think is viewed as still having a pretty high hurdle," Bullard said on Bloomberg TV. "We can do that, and I think it would be effective, but we would be taking a lot more risk on our balance sheet and we'd be going further into unchartered territory."

The Fed on Wednesday decided to extend through the end of the year a bond maturity-extension program called Operation Twist, in which the central bank replaces short-term debt it holds with longer-term securities. Operation Twist had been due to end next week.

It opted not to do QE3, which would involve outright large-scale purchases of securities.

Bullard rotates into a policy voting position next year.

Only one Fed official who can vote on policy, Jeffrey Lacker, president of the Richmond Fed Bank, dissented against the extension of Twist on grounds it would risk higher inflation and does little to boost the economy.

"I do not believe that further monetary stimulus would make a substantial difference for economic growth and employment without increasing inflation by more than would be desirable," Lacker said in a statement.

Specifically, Lacker pointed to the central bank's newly established 2-percent inflation goal as a hurdle to further monetary support, despite signs that the labor market has taken a turn for the worse.

He said "a significant increase in inflation could threaten the Fed's credibility" and make it more difficult to achieve its longer run goals, but noted the central bank might consider more policy action if the economy experienced a "substantial and persistent" decline in inflation.

While Lacker is an inflation hawk who has opposed every one of the central bank's decisions since rotating into a voting seat this year, Bullard is more of a policy centrist who this year has expressed increasing unease with the Fed's aggressive moves.

The pair were the first Fed policymakers besides Chairman Ben Bernanke to speak publicly after the Fed's two-day meeting, at which Europe's simmering debt crisis and three straight months of lackluster U.S. jobs growth loomed large.

Many analysts saw this week's $267 billion extension of Operation Twist as the precursor to further stimulus.

Bullard said it is a "contentious time" for policymaking and warned the Fed's near-zero interest rate policy may start to distort the U.S. economy.

"I am worried that you get three and a half years at zero rates and promises to keep it at zero for this much longer, that you're starting to distort the economy in ways that we're not used to in the past," Bullard said.

"This is getting outside of normal business cycle adjustments."

The Fed has kept rates ultra low since late 2008 and has made a conditional pledge to keep them there through at least late 2014. It has bought more than $2 trillion in assets in two rounds of quantitative easing, QE1 and QE2, to battle the recession.

(Additional reporting by Pedro Nicolaci da Costa in Washington; Editing by Neil Stempleman)