Fed policy might trigger bubbles, inflation: George

KANSAS CITY, Missouri Thu Jan 10, 2013 3:23pm EST

KANSAS CITY, Missouri (Reuters) - The Federal Reserve might be contributing to the next asset price bubble through its aggressive purchase of bonds to spur U.S. growth, while its near-zero interest rates could trigger future inflation, a senior Fed official said on Thursday.

Kansas City Federal Reserve Bank President Esther George, in remarks that will clearly stamp her as a hawk on the U.S. central bank's policy-setting committee, went out of her way to make clear she is not comfortable with recent Fed action.

"A prolonged period of zero interest rates may substantially increase the risks of future financial imbalances and hamper attainment of the FOMC's 2 percent inflation goal in the future," she said in a speech on the economic outlook to a business group.

"Prices of assets such as bonds, agricultural land, and high-yield and leveraged loans are at historically high levels. A sharp correction in asset prices could be destabilizing," she added.

George, asked directly after her speech if she thought there was a bubble in the bond market, said she did not know, which was why it was so important to keep the issue under close watch.

George is a voter on the Federal Open Market Committee this year, marking the first time she will be voting directly in policy decisions since she took over at the Kansas City Fed in October 2011.

"Monetary policy, by contributing to financial imbalances and instability, can just as easily aggravate unemployment as heal it," she said.

The Fed voted last month to keep up asset purchases at an $85 billion monthly pace in an effort to drive down borrowing costs and spur hiring. It said it would continue this policy of so-called quantitative easing until there was a substantial improvement in the outlook for the labor market.

Subsequent minutes of the December 11-12 meeting showed that several of the 19 officials who took part in the meeting thought the labor market would improve sufficiently to halt bond buying at some stage this year.

George, asked during a question and answer session following the speech if she favored halting asset purchases at some stage this year, declined to say what course of action she favored.

The Fed also pledged last month to hold interest rates near zero until unemployment falls to 6.5 percent, provided projected inflation does not rise above 2.5 percent.

George expected the U.S. economy to grow just above a 2 percent in 2013, while unemployment falls around another half percentage point. The U.S. jobless rate in December was 7.8 percent.

Nonetheless, she highlighted a series of risks if the Fed continues to buy bonds at this rate, indicating little appetite from her side for a prolonged Fed commitment to this policy.

"These purchases also have their own set of risks and are not without cost," she said. "At their current level and pace of growth, I believe they almost certainly increase the risk of complicating the FOMC's exit strategy."

Fed watchers have not heard much from George since she became a policy maker. George has limited her remarks, but Fed watchers had anticipated she would follow her predecessor Thomas Hoenig in holding hawkish views.

The speech's emphasis on the costs of the Fed's bond buying and ultra-accommodative policy also suggests she might be inclined to dissent at the next policy-meeting on January 29-30.

Fed critics have long argued that its massive asset purchases, which have tripled the size of its balance sheet to around $2.8 trillion, and zero rate policy could stoke future asset bubbles and George aligned herself with those concerns.

(Reporting by Alister Bull; Editing by Neil Stempleman)

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