UPDATE 1-Fed's Lacker wary on inflation, sees U.S. recovery

(Adds comments on recession, interest rates)

By Adam Entous

JERUSALEM, Nov 3 (Reuters) - The Federal Reserve must not forget about inflation as it battles recession, or leave interest rates too low for too long next year, policy-maker Jeffrey Lacker said on Monday.

"It is crucial that we not allow expectations of future inflation to ratchet higher during this recession," the Federal Reserve Bank of Richmond president said in a speech at the Hebrew University of Jerusalem.

"As a recovery begins, the path of least resistance is often to hold the policy rate at a low level until it is completely clear that recuperation is complete," " he said.

"The risk associated with that path is that inflation may not moderate obediently during the downturn, and may firm with the ensuing recovery."

Speaking to reporters after the speech, Lacker said that while the U.S. economy was definitely in a recession he believed it would be fairly moderate in size.

"We are in a contraction. Up until the summer it was a fairly mild recession," said Lacker, who will become a voting member of the Fed's interest rate-setting committee next year.

"I think it's definitely a recession at this point. How deep, how steep, and (how) long it's going to be is uncertain. We don't know if it's going to be a garden variety recession or something steeper. I think it's most likely to be of a fairly moderate size," he said.

Lacker has earned a reputation as one of the U.S. central bank's most hawkish policy-makers with a track record for warning on inflation.

Indeed, his comments differed in tone to the Fed's last policy statement on Oct. 29 [ID:nTRS000089], when it lowered interest rates by half a percentage point to 1.00 percent.

In the statement, it stressed downside risks to growth remained and tamed its warnings on inflation.

The U.S. central bank has slashed rates by 4.25 percentage points since September 2007 to try to cushion the economy from a global credit crisis sparked by the deepest decline in the U.S. housing market since the Great Depression.

Investors bet that it will ease rates again at its next meeting on Dec. 16.

Asked if rates could drop below 1 percent, Lacker said: "I haven't set a specific floor in my mind for how low."

Further rate cuts would depend on economic data, he added.