Fed's Plosser: take back ease once markets calm

By Alister Bull

WASHINGTON (Reuters) - U.S. financial turmoil has warranted aggressive Federal Reserve rate cuts but inflation is also a concern and the policy easing should be withdrawn as markets calm, a senior Fed policymaker said on Monday.

"The severity of events affecting the smooth functioning of financial markets suggests that rates, perhaps, should be somewhat lower than simple rules might suggest," Plosser said in remarks to the National Association for Business Economics.

"Departures from the more systematic elements of making policy decisions must be relatively transitory and reversed in due course if we are to keep expectations of future inflation well-anchored," said Plosser, who is a voting member of the Fed's policy-setting committee this year.

The Fed has slashed interest rates by 2.25 percentage points since mid-September to shield the economy from a collapse in the housing market, which has chilled growth and sparked a global tightening in credit conditions.

"I'm looking for some stability in financial markets because I think that it what we are trying to insure against -- some downside risks there," Plosser told reporters after the speech. "As we get more comfortable with that...that will be a time to think about 'OK, things are functioning like they should, it is time to take this back," he said.

Housing's fortunes will be critical to restoring wider market calm and Plosser said that he believed home prices would stop declining in the course of this year, helping the sector to start to turn around by mid to late 2008.

The Fed has created special Term Auction Facilities to better direct liquidity to financial institutions that need it and Fed Board Governor Randall Kroszner separately signaled that this emergency measure might be needed for a while.

"The TAF function, which I believe has had beneficial effects on financial markets to date, is expected to continue as long as necessary to address elevated pressures in short-term funding markets," Kroszner said in remarks prepared for delivery to the Institute of International Bankers.

Kroszner did not comment on the outlook for the economy or interest rates in his prepared text.

PLOSSER: NO RECESSION

Plosser acknowledged growth was "very, very slow" at the moment, but he stressed it should pick up in the second half of the year and said that the economy ought escape a recession.

"My own forecast is that we will (skirt a recession). We will have very, very slow growth in the first half of the year...and that is uncomfortable," Plosser said.

"But I think that there is a good chance that the economy will begin to turn around in mid-year (or) in the later half of the year, and we will see somewhat more respectable, closer to trend-like growth near the end of the year," he said.

Doubts over the outlook for the U.S. economy as well as the muscular policy response of the Fed, have contributed to a sharp decline in the dollar, which touched a fresh low against a basket of major currencies on Monday. Lower rates potentially make dollars less attractive for foreign investors.

Plosser said it was very difficult to forecast exchange rates with any accuracy, but he acknowledged the U.S. current account deficit might be weighing on the currency.