A top Federal Reserve official on Tuesday added her voice to those at the U.S. central bank who wanted to reduce asset purchases last month, though she stressed that "very supportive" policies remain essential to support the economy.
"For me the improvement in labor markets seemed substantial enough to support a scaling back of the asset purchase program at last month's FOMC meeting," said Cleveland Fed President Sandra Pianalto, who does not have a vote on policy this year, and who is retiring early next year.
In deciding September 18 to keep buying $85 billion in Treasury and mortgage bonds each month, the Fed surprised investors globally who had widely expected it to trim the program known as quantitative easing, or QE3 because it's the Fed's third such easing effort since the Great Recession.
That decision sparked a surge in stocks globally that has now evaporated as political gridlock in Washington has raised fears over a U.S. debt default, which Pianalto flagged as a risk to the economy.
Pianalto is known as a policy centrist who supports Fed Chairman Ben Bernanke's decisions, so the admission is unusual and aligns her more closely to the minority of policy hawks who have been urging their Fed colleagues to scale back monetary accommodation.
She said the policy-setting Federal Open Market Committee (FOMC) wanted more evidence the economic recovery's progress will be sustained before making its move.
"I hope that the additional evidence that the committee is looking for arrives soon," she told the Economic Club of Pittsburgh and CFA Society Pittsburgh.
"We have limited experience with asset purchases so it pays to be cautious, especially in this uncertain economic environment," Pianalto added. "While to date the risks have mostly remained theoretical, I remain convinced that we need to be cautious in our expansion of asset purchases."
Pianalto said she would serve as president of the Fed's Cleveland branch until a successor has been named; whoever it is will have an immediate vote on the Fed's monetary policy committee next year.
On a nuanced note, Pianalto said the U.S. economy "still has some way to go to regain its full health," so "very supportive monetary policy remains essential."
She forecast steady but slow improvement in the economy and a gradual reduction in unemployment, which stood at 7.3 percent in August. She expects inflation, which has been soft at 1.2 percent over the last 12 months, to gradually rise.
"I'm not concerned that we are in a disinflationary environment," she said.
Echoing comments by other Fed officials in the last week, Pianalto noted that business and consumer confidence is being shaken by the fiscal standoff in Washington.
A standoff in the U.S. Congress has shut down the federal government. Meanwhile the country will run dangerously low on cash if lawmakers do not raise the federal borrowing cap by October 17, and a default could follow within a week.
Pianalto warned about uncertainty over how the debt-ceiling debate will progress in coming months, saying a default that left interest unpaid on Treasuries could erode confidence in the bonds and drive their yields higher.
Last month Bernanke and 9 of the 10 voting FOMC members pointed to restrictive fiscal policies and tighter financial conditions - including a run-up in mortgage rates over the summer - as reason to keep up the current pace of QE3, which was launched a year ago.
Charles Plosser, head of the Philadelphia Fed, was the latest policy hawk to say on Tuesday that the program should be trimmed as soon as possible.
Pianalto argued that Fed policy would still be supportive even when QE3 is reduced, given the large stable of assets it holds. In August, she suggested the Fed could soon reduce QE3.
(Reporting by Jonathan Spicer; Editing by Chizu Nomiyama)