UPDATE 1-Fed may be able to pull back on stimulus this year-Lockhart

Tue Apr 2, 2013 3:06pm EDT

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By Pedro Nicolaci da Costa

BIRMINGHAM, Ala., April 2 (Reuters) - The Federal Reserve may be able to reduce its bond-buying stimulus plan before the end of this year if economic growth continues to pick up and employment improves further, a top central bank official said.

Dennis Lockhart, president of the Atlanta Fed, said on Tuesday he expects the U.S. economy to expand a bit over 2 percent this year, though he does see some chance that the expansion could prove even stronger.

At the same time, Lockhart flagged short-term budget cuts from Washington as a risk to near-term economic performance. He also noted the U.S. labor market, while better, remains only a shadow of its pre-recession self.

"Conditions in the broad labor market are quite mixed," he said, adding that he was still cautious about recent signs of economic strength.

The U.S. economy added 236,000 jobs in February, well above forecasts, while the jobless rate fell to 7.7 percent.

"We saw strong data in the early months of 2012 followed by a mid-year swoon," Lockhart told the Kiwanis Club of Birmingham. "So I think it is appropriate to be a bit cautious in extrapolating these recent employment trends. More evidence is needed."

Lockhart said inflation remains contained as do inflation expectations, giving the central bank room to maneuver. Still, he acknowledged there are potential costs from the Fed's expanded balance sheet which, at around $3.2 trillion, is around four times its pre-crisis size.

With official interest rates already at zero for the last four years, the Fed is currently purchasing $85 billion in mortgage and Treasury bonds per month in an effort to keep long-term rates down to spur investment and consumption.

Critics of the policy say it could spur future inflation, though there is little evidence to date to support such concerns. Indeed, the Fed's preferred inflation measure is forecast to run below the central bank's 2 percent target for the foreseeable future.

Lockhart said recent gains in stock and home prices were bolstering consumer confidence and spending.

He also argued that, despite recent ructions out of Cyprus, the risks to the U.S. economy and financial system from the euro zone crisis have diminished.

"The potential for a shock coming from Europe is smaller today than it was a year ago," he said, adding that he believes Cyprus was a special situation and that contagion to other nations is unlikely.

Playing down the risk of financial instability due to the Fed's quantitative easing policies, Lockhart said the benefits of bond-buying still outweigh the risks.

"I don't believe at the moment that we have any deep asset class markets that are showing signs of bubble characteristics," he told reporters after the speech.

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