By Lindsay Dunsmuir and Jason Lange
WASHINGTON (Reuters) - Federal Reserve policymakers appeared increasingly wary about recent weak inflation and some called for halting interest rate hikes until it was clear the trend was transitory, according to the minutes of the U.S. central bank's last policy meeting.
The readout of the July 25-26 meeting, released on Wednesday, also indicated the Fed was poised to begin reducing its $4.2 trillion portfolio of Treasury bonds and mortgage-backed securities.
Last month's meeting, which concluded with a unanimous decision to leave rates unchanged, was marked by a lengthy discussion about the recent soft inflation readings, the minutes showed.
The central bank's preferred inflation measure dropped to 1.5 percent in June from 1.8 percent in February and has remained below its 2 percent target for more than five years.
"Many participants ... saw some likelihood that inflation might remain below 2 percent for longer than they currently expected, and several indicated that the risks to the inflation outlook could be tilted to the downside," the Fed said in the minutes.
The inflation retreat has spurred concerns the Fed may have to cool its monetary tightening pace even though the economy is growing moderately and the unemployment rate fell to 4.3 percent in July, matching a 16-year low touched in May.
The Fed has raised its benchmark overnight lending rate twice this year and forecasts one more rise before the end of 2017.
Some policymakers argued last month against future rate rises until there was more concrete evidence that inflation was moving back toward the Fed's objective, according to the minutes.
Others, however, cautioned that such a delay could cause an eventual overshooting in inflation given a tightening labor market "that would likely be costly to reverse."
BALANCE SHEET REDUCTION
In an interview with Reuters on Wednesday, Cleveland Fed President Loretta Mester said, "I'm not one who would like to see inflation be at 2 percent before we continue on the path" of rate hikes because policy affects the economy with a lag.
"On the other hand, we do have to take into account that we have had weak readings on inflation," Mester added.
Senior Fed officials have largely dismissed the inflation softness as temporary. Fed Chair Janet Yellen said last month that special factors, including price drops for mobile phone plans and prescription drugs, were partly responsible.
Voting members of the Fed' rate-setting committee agreed to monitor inflation closely in light of the concerns, with a few policymakers cautioning that the central bank's framework for analyzing inflation was "not particularly useful," according to the minutes.
"What it boils down to is what inflation will do between here and December," said Eric Winograd, an economist at Alliance Bernstein, who still expects the Fed to raise rates again at its Dec. 12-13 meeting.
The dollar (.DXY) was weaker against a basket of currencies. U.S. stocks ended slightly stronger after paring earlier gains and prices of U.S. Treasuries were higher.
Fed policymakers at last month's meeting also cast a keener light on financial stability and agreed it was important to look for signs of declining market volatility or concentration of investors in particular assets.
Elsewhere in the minutes, Fed officials reinforced expectations of an announcement in September to begin reducing the central bank's holdings of bonds that were bought in the wake of the 2007-2009 financial crisis and recession.
Several policymakers were prepared to announce a start date last month, but the Fed decided to wait as "most preferred to defer that decision until an upcoming meeting."
Fed officials have been priming markets for a probable move at their next policy meeting on Sept. 19-20. New York Fed President William Dudley said on Monday the expectation of such an announcement next month was not unreasonable.
(Reporting by Lindsay Dunsmuir and Jason Lange; Additional reporting by Jonathan Spicer and Howard Schneider in New York; Editing by Paul Simao)