Fed officials vow to keep watch on inflation

NEW YORK (Reuters) - The Federal Reserve's rapid-fire interest rate reductions were warranted, but the central bank must reverse course quickly once calm is restored to financial markets, Fed officials said on Friday.

In a series of speeches in New York and Atlanta -- one day after Fed Chairman Ben Bernanke fielded sharp questions from members of Congress worried about rising inflation -- Fed presidents stressed that they had not forgotten their responsibility for ensuring stable prices.

"Importantly, when (rate cut) insurance proves to be no longer necessary, removing it promptly and recalibrating policy to appropriate levels will reiterate and reinforce our commitment" to the goals of achieving price stability and maximum employment over the medium term, Chicago Fed President Charles Evans said in a speech in New York.

His counterpart from the St. Louis Fed, William Poole, said the central bank had good reason to lower rates in response to a weakening job market and financial sector unrest, but added that neglecting inflation had serious consequences.

The Fed "should give primacy to the inflation objective because if inflation develops while the (Fed) is concentrating on avoiding recession, the consequence will be to delay recession but not to avoid it," he said.

"Most likely, the delayed recession in an environment of rising inflation and rising inflation expectations will be worse than the mild recession avoided in the immediate future," he added.

The Fed has lowered interest rates by 2.25 percentage points since mid-September in a bid to avert a recession sparked by the slumping housing market and tightening credit conditions. Another rate cut is widely expected at the next policy-setting meeting on March 18.

While Wall Street has clamored for swift easing to prop up the faltering economy, some economists have begun raising concerns about stubbornly high inflation that is devouring a growing portion of household budgets.

The Fed's favored inflation gauge, the core personal consumption expenditure price index, rose 2.2 percent in January on a year-over-year basis, according to data released on Friday. That was above the Fed's perceived comfort zone, which tops out at about 2 percent.

That poses another threat to consumer spending, which is the lifeblood of the U.S. economy.

Households were already grappling with credit constraints as banks tighten lending terms in the wake of their multi-billion-dollar losses tied to bad debts. Fed Governor Frederic Mishkin said mortgage losses had caused an amplified pullback in bank lending.

That concern was echoed by Atlanta Fed President Dennis Lockhart, who expressed a worry that heavy credit card debt and lower prices for homes and other assets could constrain spending.

Lockhart said the Fed's rate cuts should spur stronger growth in the second half of the year, but financial market problems won't fade until the housing market stabilizes. When that will happen is unclear, he added.

Boston Fed President Eric Rosengren said lower interest rates would likely lead to a lower foreclosure rates and reduce some of the pressures in the housing market. However, further housing declines would pile pressure on banks' balance sheets.

(Reporting by Alister Bull in Atlanta, Tim Ahmann and Lisa Lambert in Washington, and Gertrude Chavez-Dreyfuss and Mark Felsenthal in New York; Writing by Emily Kaiser, Editing by Chizu Nomiyama)