U.S. economic recovery close at hand: Fed's Stern

CHICAGO (Reuters) - A U.S. economic recovery seems "close" after a deep and prolonged recession but growth will be modest into next year, Gary Stern, president of the Minneapolis Federal Reserve Bank, said on Thursday.

"I continue to think that improvement in the economy is close at hand," Stern said in remarks prepared for a speech to business leaders in Helena, Montana, adding "healthy growth" can be expected from the middle of 2010 and beyond.

Stern played down concerns about "a potential burst of inflation" as a result of the Fed's policies to backstop credit markets as a threat to the economy.

The kind of volatility seen in recent data is often a sign a recovery is on the way, Stern said.

"At economic turning points ... the data are invariably mixed, and there now are in fact positive signs of stabilization," Stern said.

Those signs range from consumer spending to manufacturing, to various measures of residential real estate, he said, while financial conditions have "demonstrably improved" and credit is more available to households and businesses than just a few months ago.

Stern, 64, the longest serving regional Fed president, is not a voting member of the U.S. central bank's policy-setting Federal Open Market Committee in 2009. He has said he intends to step down this summer once a replacement has been chosen.

The huge expansion of the Fed's balance sheet, from about $1 trillion last September to about $2 trillion, has been "justified," Stern said, adding that "there is nothing inevitable about a surge in prices" as a result.

"The Federal Reserve is fully capable of shrinking its balance sheet when it is appropriate to do so. Without question, it will be difficult to know when to begin such action and how rapidly to proceed," he said.

Central banks have succeeded in keeping inflation low since the early 1980s, Stern said. "I can think of no reason why this cannot continue."

Stern said he was more worried about the potential for sharp volatility in asset prices at some point in the future.

The Fed may need to reconsider its attitude to attacking perceived asset bubbles, such as the housing boom that gave way to such a damaging bust over the past few years, Stern said.

"Identification of excesses in asset prices, although challenging, does not appear to be beyond the realm of possibility."

A key to changing the approach would have to have public support, Stern said, adding:

"Such actions are likely to require raising interest rates earlier and probably more than would otherwise be the case ... Policy-makers need to weigh these elements carefully."

(Editing by James Dalgleish)