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Fed's Williams sees no rate hike until after mid-2015

John Williams, president and chief executive of the Federal Reserve Bank of San Francisco, speaks in a panel discussion titled "U.S. Overview: Is the Recovery Sustainable" at the Milken Institute Global Conference in Beverly Hills, California May 1, 2012. REUTERS/Danny Moloshok

By Ann Saphir

SUN VALLEY Idaho (Reuters) - The Federal Reserve will probably need to keep interest rates near zero for at least another year, a top Fed official said on Monday, even as he expressed optimism the economy is well on its way to health.

"As things get better we can kind of get back to our normal approach to policy," San Francisco Fed President John Williams told members of the Utah and Montana Bankers Association, predicting full employment and normal inflation by the "early part" of 2016.

The Fed has bought trillions of dollars of long-term securities and kept interest rates near zero since December 2008 in an effort to boost employment and keep the economy from becoming mired in a growth-sapping, downward price spiral.

Now, with economic growth picking up, unemployment falling, and inflation showing signs of rising back to more healthy levels, the Fed is winding down its massive bond-buying program with plans to end it this fall.

As for rate rises, he said, "I still see that as some time off in the future," telling reporters that he still believes a rate rise will not be appropriate until the second half of 2015.

The Fed should "stop answering" questions about precisely when it will raise rates, he said, because markets can swing strongly if expectations suddenly shift.

That, he said, was the lesson of last year's so-called "taper tantrum," when markets swooned after then Fed Chair Ben Bernanke suggested the bond-buying program could end sooner than many investors had been convinced it would.

Once rates rise, the Fed will eventually shrink its swollen balance sheet to something "significantly smaller" than its current level of more than $4 trillion, he said. He said he would prefer the Fed's portfolio to eventually contain no mortgage-backed securities, but said the Fed has years to decide whether it will sell any assets to get there.

Williams forecast real GDP would bounce back from its shocking decline in the first quarter, to grow at a pace faster than three percent through the end of 2014, and then a bit above three percent in 2015 and 2016.

That will be fast enough, he said, to push the current unemployment rate of 6.3 percent to 6 percent by the end of this year and 5.5 percent by the end of next year.

The economy will likely reach full employment, which Williams sees as a jobless rate of about 5.25 percent, by the "early part" of 2016, he said.

Inflation, which has been stuck below the Fed's 2-percent target for years, will rise gradually back to that level as the economy nears full employment, he said. It could rise above that level under some scenarios, he said, expressing little discomfort with such an outcome as long as the average level over the medium term is near 2 percent.

"The bottom line is, it has worked," of the Fed's extraordinarily stimulative policies since the Great Recession.

(Reporting by Ann Saphir; Editing by Chizu Nomiyama)