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Fed officials see recovery firm even as gas costs weigh

A taxicab driver fills his tank at a gas station in mid-town Manhattan in New York, April 11, 2011. REUTERS/Brendan McDermid
A taxicab driver fills his tank at a gas station in mid-town Manhattan in New York, April 11, 2011. REUTERS/Brendan McDermid

By Mark Felsenthal

CAPE GIRARDEAU, Missouri (Reuters) - Federal Reserve officials on Tuesday expressed confidence in the U.S. economic recovery despite high gas prices and European financial jitters, and one suggested the U.S. central bank could reverse its ultra-loose monetary policy this year.

"I do believe we're in a sustainable economic recovery. We face some risks, but we always face some risks," James Bullard, president of the St. Louis Fed, told reporters after a speech to a Rotary Club group.

Bullard said in his speech that if the recovery goes well, the Fed could begin in the second half of the year to tighten policies that have kept interest rates near zero since December 2008 and that will result in $2.3 trillion in securities purchases to stimulate growth.

Nevertheless, Bullard said the Fed would likely not change its policy immediately after the end next month of its $600 billion bond-buying program, designed to stimulate the economy, but would stay on hold "for a couple of meetings."

That would mean the Fed would keep rates near zero, reinvest maturing securities to hold its portfolio at a steady size, and continue to promise low rates for a long time, he said.

The Fed at its most recent policy meeting in June signaled the latest round of bond buying is likely to be the end of its actions to support the recovery. Still, Fed Chairman Ben Bernanke signaled after the meeting that policy makers would likely be in no rush to pull back easy money policies while unemployment remains high.

Bullard cited financial instability stemming from the European sovereign debt crisis as the top risk to the U.S. economic recovery. He also acknowledged that many Americans are feeling the pinch from higher energy and food prices. Fed Governor Elizabeth Duke sounded a similar theme.

"Many families, particularly those with low-to-moderate incomes, are actually facing the decision between buying gas to drive long distances to work and paying their mortgage," Duke told a conference sponsored by the Boston Fed..

After a retreat in crude oil prices, average U.S. gasoline costs fell to $3.85 a gallon in the latest week, the Energy Department said on Monday. Although prices are down 11.1 cents from the previous week, the national gasoline price is still $1.06 a gallon above a year ago.

The U.S. economy appears to have hit a soft patch in recent months after several quarters of strong growth. U.S. gross domestic product expanded at an annualized rate of just 1.8 percent in the first quarter.

However, Cleveland Federal Reserve President Sandra Pianalto said in the bank's annual report released Tuesday that the economy was on firmer footing despite recent oil price spikes.

"Employers are creating new jobs, and there are signs that job growth will accelerate as the year progresses," she said.

But inflation fears are mounting, she said, threatening to undermine those gains.

In a sign of pressure within the Fed to respond to the improving economy by tightening financial conditions, two regional Fed banks again sought a modest increase in the rate for emergency bank loans, minutes of Fed Reserve board meetings in March and April showed on Tuesday.

Directors of Federal Reserve banks in Kansas City and Dallas sought to raise the discount rate by 0.25 percentage point, but the other 10 regional Fed banks argued the rate should be left at 0.75 percent. The U.S. central bank's board sided with the majority.

The Kansas City and Dallas Fed banks have for months sought to raise the discount rate to 1 percent as a step toward moving the spread between it and the benchmark federal funds rate closer to pre-crisis levels.

In addition, the Fed took further steps to put in place the tools it will need to pull back the flood of bank reserves it pumped into the economy during the crisis with low rates and asset purchases.

The New York Fed laid out the criteria for Fannie Mae, Freddie Mac and other government-sponsored entities to become counterparties it could tap to help drain the $1.5 trillion in excess reserves from the banking system.

Tuesday's announcement is not a signal on the timing of the central bank's tightening policy but it is seen as one of the last steps for the Fed to put in place tools necessary to increase in the federal funds rate.