September 7, 2017 / 4:47 PM / a year ago

Fed's Mester sees gradual rate hikes as helping amid uncertainty

Loretta Mester, president of the Federal Reserve Bank of Cleveland, speaks during an interview in Manhattan, New York, U.S., August 15, 2017. REUTERS/Shannon Stapleton

(Reuters) - The Federal Reserve should stick to its plan to raise interest rates gradually to keep the economy from overheating and financial imbalances in check, a U.S. central banker said on Thursday, even as fiscal and political uncertainty temper business optimism.

The Fed has raised interest rates twice this year, and policymakers in June pointed to one more rate hike this year and three next year. This would be a slow-but-sure approach to tightening monetary policy that Fed Chair Janet Yellen said was justified by improvements in the labor market and the conviction that inflation will return to 2 percent over the next couple of years.

“If economic conditions evolve as anticipated, I believe further removal of accommodation via gradual increases in the fed funds rate will be needed and will help sustain the expansion,” Cleveland Fed President Loretta Mester said in remarks prepared for delivery in Pittburgh. “I see this consistency as a positive in that it underscores our systematic approach to promoting our policy goals and it removes policy ambiguity at a time when uncertainty seems to be rising on other fronts.”

Mester, who next votes on Fed policy in 2018, repeated many of the forecasts she has made in recent months, including her view that the U.S. economy will grow above the 2 percent pace she believes is its long-term trend, keeping unemployment below 4.75 percent and allowing inflation to return to the Fed’s 2-percent target in the next year or so.

She also said that while she is encouraged by business investment and activity, supported by high levels of business optimism, “some of my business contacts report that mounting political and fiscal policy uncertainty has begun to temper some of that optimism.”

The Trump administration has struggled to make good on the legislative promises from its campaign including a plan to reform the tax system and to repeal and replace the Affordable Health Act, the signature health insurance program of former President Barack Obama.

If reduced optimism leads to a pullback in investment in capital or innovations, Mester said, productivity growth, already sluggish and likely the biggest cause of tepid wage increases, could suffer.

Mester said she continues to back a plan to begin reducing the Fed’s $4.5 trillion balance sheet “in the near future”. The plan, she said, has been well-telegraphed and is so gradual that she expects no big or sharp increases in long-term yields to result.

Reporting by Ann Saphir; Editing by Chizu Nomiyama

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