Fed's Hoenig says rate policy could go either way

By Ros Krasny

DENVER (Reuters) - Kansas City Federal Reserve President Thomas Hoenig said on Tuesday that future Federal Reserve policy moves could still go either way, given a variety of cross-currents to growth and inflation.

Current interest rates are "modestly firm," and a case could be made for either a rate rise or a rate cut, Hoenig said in a speech to local business leaders.

Last week, the Federal Open Market Committee (FOMC) left overnight interest rates unchanged at 5.25 percent for a seventh consecutive meeting, citing inflation as its key concern.

Financial markets expect the Fed's rate hold to continue at the June meeting, and are pricing a lone rate cut in 2007. But markets do not sense that the Fed is likely to raise rates given recent below-trend economic growth.

Among the key risks to growth, Hoenig cited the weak housing market and slower business investment. Meanwhile, strong exports, partly a function of the weak U.S. dollar, were termed a plus for the economy.

The current spell of below-potential growth should continue to bring inflation down over time, he said.

"We are growing slowly enough that we should some slight increase in unemployment from current levels," which should help the downward inflation trajectory, Hoenig said.

Hoenig, a voting member of the FOMC this year, said that real GDP growth should climb back above 2 percent over the course of 2007, and that growth in 2008 should be higher.

Hoenig also said that any decision on whether to adopt formal inflation targets was "still a ways off."

There needs to be a lot more discussion within the Fed and among the academic community on the topic of targets, Hoenig told local business leaders while answering questions after a speech.

Targeting was just one of a number of options that the Fed will consider to improve its communications about policy matters, he added.

Answering questions from the audience, Hoenig repeated the central bank's commitment to low and stable prices.

"Historically, an economy that has an environment of stable prices functions better over time," he noted.