Yellen says Fed should not rush to reverse policy

By Ros Krasny

SAN FRANCISCO (Reuters) - Top Federal Reserve officials said on Tuesday the central bank should not rush to raise interest rates or remove other accommodative policies as soon as the U.S. economy climbs out of recession.

In fact, given prospects for a very slow recovery marked by high unemployment, the Fed's key interest rate could stay near zero for years, said Janet Yellen, President of the San Francisco Fed.

"It's not outside the realm of possibilities that the fed funds rate could stay at zero for the next couple of years," Yellen told reporters after a speech in San Francisco.

In contrast to some of her colleagues, Yellen debunked worries that the United States would be driven into high inflation by the Fed's accommodative policies.

Indeed, Yellen said core inflation, stripped of volatile food and energy prices, could fall toward 1 percent in the next year -- well below her preferred level of 2 percent.

"The predominant risk is that inflation will be too low, not too high, over the next several years."

Yellen said she was baffled by fears of a "cataclysmic" surge in inflation, and said market forecasts for an imminent rate increase were "jumping the gun."

Short-term interest rate futures, which measure market sentiment toward Fed policy, show about a 50-percent chance for a rate increase before the end of 2009. The fed funds rate has been in a range of zero to 0.25 percent since December.

"History shows us that this kind of (inflationary) concern has caused central banks, both ourselves and Japan, to tighten too early," Yellen said.

"I do not believe that there is a real threat of high inflation in the current situation."

FIND YOUR NEAREST EXIT

Earlier, James Bullard, President of the St Louis Fed, also said that the bank's very accommodative monetary policy will remain in place for an extended period.

A premature exit could thwart the recovery that most forecasters now anticipate, Bullard said at a Global Interdependence Center event at the Philadelphia Fed.

Still, Bullard, one of the Fed's more hawkish policymakers, warned of the need for a defined exit strategy by the Fed to control inflation expectations.

Selling Fed-held assets was probably the most likely way it would choose to go, Bullard said.