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Fed could do 'small' QE3 taper to recognize job gains: Bullard

James Bullard, President of the St. Louis Federal Reserve Bank, speaks during an interview with Reuters in Boston, Massachusetts August 2, 2013. REUTERS/Brian Snyder

(Reuters) - Improvements in the U.S. job market make reductions to the Federal Reserve's massive bond-buying program more likely, a top Fed official said on Monday, suggesting the central bank could start small and reassess in the first half of 2014.

U.S. central bank policymakers meet on December 17-18 but are widely expected to defer a reduction in their bond-buying program to next year.

St. Louis Fed President James Bullard said that the probability of easing back the pace of asset purchases had increased and one possible reaction to a recent run of upbeat data was a small taper at "the upcoming meeting."

"A small taper might recognize labor market improvement while still providing the (Fed's policy-setting) committee the opportunity to carefully monitor inflation during the first half of 2014," he said in slides prepared for delivery to the CFA Society St. Louis.

"Should inflation not return toward target, the committee could pause tapering at subsequent meetings."

The Fed has been buying $85 billion in Treasuries and mortgage-backed securities since September 2012 to boost investment, growth and hiring.

Bullard said tapering the purchases would reflect the improvement in labor markets since the program began, a process which was likely to continue. Unemployment registered 7 percent last month, down from 7.9 percent at the start of the program.

Still, he said, inflation has lagged below the Fed's 2 percent target for reasons that are hard to pinpoint.

The Fed has promised to keep rates near zero even after it stops buying bonds, until unemployment falls to at least 6.5 percent, as long as inflation does not threaten to rise above 2.5 percent.

Bullard opposes vowing to keep rates low until unemployment falls to an even lower level, saying that changing the unemployment threshold could hurt the Fed's credibility.

While he would prefer a Fed promise not to increase rates unless inflation rises above a certain level, say 1.5 percent, a so-called inflation floor has not won widespread support among his colleagues.

Verbal guidance from the Fed chair that rates will stay low until even after the unemployment rate hits 6.5 percent would be less complicated and "possibly just as effective" in convincing markets that rates won't soon rise after the Fed begins winding down its bond buying, Bullard said.

(Reporting by Ann Saphir and Jason Lange; Editing by Krista Hughes)