Fed's George warns unwinding balance sheet could disrupt markets

Tue Feb 12, 2013 1:16pm EST

(Reuters) - The Federal Reserve could disrupt markets if it actively sells large amounts of mortgage-backed securities when the time comes to tighten monetary policy, a top U.S. central bank official said on Tuesday.

Kansas City Fed President Esther George, a hawkish voter who dissented at a Fed policy meeting last month, also warned that investors could question the central bank's commitment to its 2-percent inflation goal if inflation expectations begin to rise.

In a speech at the University of Nebraska-Omaha, George largely repeated a handful of risks she had previously raised over the Fed's policies, which include near-zero interest rates and $85 billion in monthly purchases of Treasury bonds and mortgage debt.

When the time finally comes, "actively selling a large amount of agency mortgage backed securities ... could be potentially disruptive to markets and market functioning," she said, adding: "These actions are untested."

In December, the Fed unveiled a so-called thresholds plan in which it pledged to keep interest rates ultra low until unemployment drops to 6.5 percent, from 7.9 percent last month, as long as inflation expectations remain below 2.5 percent.

In adopting these thresholds, the Fed has expressed some tolerance for having the inflation outlook exceed its 2-percent goal, George said. That in turn "carries with it the risk that longer-term inflation expectations may flip above levels consistent with" the goal, and "cause the market to question the Federal Reserve's commitment to its inflation goal," she said.

Long-term inflation expectations usually predict actual inflation, George noted.

So far this year, U.S. inflation expectations have edged higher.

(Reporting by Jonathan Spicer and Steven C. Johnson in New York; Editing by Chizu Nomiyama)

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