* Dallas Fed's Fisher: May need to "taper" off bond buying
* St Louis Fed's Bullard: Purchases could be cut "somewhat"
* San Francisco Fed's William supports continued purchases
By Jonathan Spicer and Ann Saphir
NEW YORK/DALLAS Feb 21 Two top Federal Reserve officials on Thursday signaled support for scaling back the U.S. central bank's aggressive bond-buying program, adding fuel to a contentious debate over how long the Fed should continue its extraordinary measures to support the economy.
But even as James Bullard, president of the St. Louis Federal Reserve Bank, and Richard Fisher, president of the Dallas Fed, both considered inflation hawks, lent support to the argument favoring a move to tighten monetary policy, another policymaker known for his dovish stance said the Fed should keep buying bonds until well into the second half of this year.
The latest remarks from Fed officials amounted to a doubling down on their previous comments, underlining long-held divisions among the central bank's 19 policymakers. They come as investors grow increasingly sensitive to signs of policy change, and as data on Thursday indicated the U.S. economy continues to struggle to regain strength.
Financial markets are abuzz with speculation on just how long the central bank will continue its program of buying bonds at a monthly pace of $85 billion. The Fed's asset purchases have resulted in a flood of liquidity that has fed a bid for riskier assets amid a climate of ultra-low interest rates.
The benchmark Standard & Poor's 500 index has gained more than 5.0 percent already this year and is trading near five-year highs.
Prices of U.S. Treasury debt have also been supported by the bond purchases, though the perceived safety of the government bonds has supported prices even as doubts have surfaced over how long the bond purchases might continue.
The Fed at its last policy meeting, on Jan. 29-30, opted to maintain the pace of bond purchases until the labor market outlook improved substantially.
But the release of the minutes of that meeting highlighted the rift among Fed officials over the risks of high inflation versus the need for continued support of a fragile economic recovery.
"A number of participants stated that an ongoing evaluation of the efficacy, costs, and risks of asset purchases might well lead the (policy-setting) committee to taper or end its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred," the minutes said.
HAWKS STAND PAT
Fisher, who is not a voting member of the Fed's policy-setting committee this year, in an interview with Reuters on Thursday said the Fed may need to "taper" off its bond-buying program rather than halt it outright.
"You don't go from wild turkey to cold turkey, you have tapering in between," Fisher told Reuters. "If the economy continues to improve, I personally would expect that to be sometime this year."
Fisher acknowledged current slow U.S. growth but said, "We should begin to taper this thing off as unemployment improves and as long as we don't see inflation rear its ugly head."
"I don't care whether you're a hawk or a dove, no one on the committee wants to do it radically. What you want to do is do it sensibly," he added.
James Bullard, of the St. Louis Fed, on Thursday also supported a gradual pullback.
"Substantial labor market improvement" does not arrive suddenly, Bullard said in a lecture at New York University. "This suggests that as labor markets improve somewhat, the pace of asset purchases could be reduced somewhat, but not ended altogether."
Bullard, who votes on policy this year, acknowledged that the size of the Fed's balance sheet, now at more than $3 trillion, may complicate or prevent a "graceful" exit from the very accommodative policies it has adopted to boost the U.S. recovery from the worst recession in decades.
"These are untested policies. It's not clear how it will end," he said. "So because there's uncertainty about that we'd rather not do more than we have to."
Talking to reporters, he repeated a proposal he floated last week that would regularly adjust the value of bond purchases to changes in the unemployment rate. "To me, that would be a better policy. You'd be more state contingent," he said.
The U.S. stock market has seen an abrupt reversal that looks set to end a seven-week rally after the release of the Fed minutes drove speculation about the bond purchases potentially ending sooner than many investors have expected. The S&P on Thursday dropped 0.68 percent a day after registering a 1.24 percent slide.
FED MISSING ON BOTH GOALS
The Fed is buying $45 billion in Treasuries and $40 billion in mortgage-backed securities per month in its third round of quantitative easing. It has also pledged to keep interest rates near zero until the unemployment rate drops to 6.5 percent, as long as inflation expectations remain contained.
The jobless rate is now at 7.9 percent.
However, John Williams, president of the San Francisco Fed and one of the central bank's more dovish members, highlighted the stubbornly high jobless rate as he called for continued bond purchases on Thursday.
"The Fed's dual mandate from Congress is to pursue maximum employment and price stability. We are missing on both of these goals," Williams said in an address at The Forecasters Club in New York. "Unemployment is far too high and inflation is too low.
As a result, Williams, who is not a voting member of the Fed's policy-setting committee this year, said the U.S. economy needs "powerful and continuing" policy stimulus.
"I anticipate that purchases of mortgage-backed securities and longer-term Treasury securities will be needed well into the second half of this year."
And he told reporters after his speech that there should not be significant tapering of bond buying "unless you were seeing the significant improvement in the outlook for the labor market."
The latest remarks came as data on Thursday cast some doubt on the strength of U.S. economic growth. News on the manufacturing sector, which has supported the economy's recovery from the 2007-09 recession, was downbeat.
A report from the Philadelphia Federal Reserve Bank showed that factory activity in the U.S. mid-Atlantic region unexpectedly contracted in February for the second month in a row, hitting an eight-month low. The report is seen as one of the first monthly indicators of the health of U.S. manufacturing and was in contrast to data last week that showed activity in New York State rebounded.
Another report from financial data firm Markit that tries to gauge overall national factory activity showed manufacturing growth slowed in February but remained near a nine-month peak.
The Labor Department reported that new claims for jobless benefits rose by 20,000 last week to a seasonally adjusted 362,000.
And another Labor Department report on Thursday showed consumer prices were flat for a second straight month in January. In the 12 months through January, consumer prices rose 1.6 percent, the smallest gain since July, suggesting there was little inflation pressure.
Williams on Thursday did not dwell on the risks associated with the Fed's bond purchases. But he did play down the concern this massive expansion would fan inflation.
"I want to assure you that in no way have we relaxed our commitment to our price stability mandate. We constantly monitor inflation trends and inflation expectations. And we will not hesitate to act if necessary," he said.
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