Fed's Plosser: Raise rates, but move judiciously

WASHINGTON (Reuters) - U.S. interest rates are low and the Federal Reserve must raise them to curb inflation, but the U.S. central bank should not ignore the real economy as it tightens policy, a top Fed official said on Wednesday.

"It's important to move in a judicious way and be careful about, and be supportive of, the economy at the same time," Philadelphia Federal Reserve Bank President Charles Plosser said during an interview on Bloomberg television.

Plosser, a voting member of the Fed's rate-setting committee this year, has dissented twice in favor of less aggressive action while the central bank was easing. He made plain the Fed could not stay on hold for a prolonged period.

"Real interest rates are negative, and we can't stay there indefinitely. We've got price pressures clearly throughout the economy," he said.

"Ultimately, rates are going to have to go up, and I think the question is the timing of that and managing, at the same time, expectations about inflation going forward."

The Fed halted an aggressive rate cut campaign last month after cutting its benchmark overnight funds rate by 3.25 percentage points to 2 percent since September to shield the economy from a credit crunch sparked by mortgage losses.

The Fed warned in the June 25 statement that inflation had risen as a risk to its outlook.

Since that date, concern over mortgage losses at mortgage finance giants Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz) have renewed strain in financial markets.

As a result, some investors have dialed down their expectations of imminent rate hikes.

Plosser agreed that the turmoil around Fannie and Freddie had made the Fed's policy task tougher and he said that market stability would be an important factor in assessing when the time was right to start raising rates.

But he also stressed that the central bank could not afford to sit on its hands while inflation pressures went unchecked.

"Most of us agree that inflation expectations currently are OK. They're anchored. ... But the anchor is dragging, and I think it is important that we act before those expectations become unhinged. Because if we wait until expectations have become unhinged, it's too late," he said.

(Reporting by Alister Bull; Editing by Jonathan Oatis)