Chicago Fed's Evans: Dec Possible for Rate Hike, Inflation Key

--'Quite Reasonable' to Begin Bal Sheet Reduction at Sept FOMC Mtg

--Monetary Policy 'Still Accommodative,' Sees Weak Infl as Temporary

--2Q GDP Growth 'Good,' Above Trend, Expect Similar Growth Going Forward

By Karen Mracek

     CHICAGO (MNI) - With a move on the balance sheet expected relatively soon,

Chicago Federal Reserve Bank President Charles Evans Tuesday kept open the

possibility of a rate hike in December -- if the recent weakness in inflation

proves to temporary as he expects it will.

     "As long as it's still a reasonable proposition that the inflation outlook

is headed back for 2% -- I still think that's the case -- then I think we can

continue to follow through on our gradual policy adjustment process," Evans said

in a group interview with MNI and other wire service reporters. "I think that's

completely reasonable."

     But first the policymaking Federal Open Market Committee will likely

initiate it's plan to end reinvestments and begin reducing the size of its

balance sheet from the $4.5 trillion level it grew to during the financial

crisis.

     "I personally think it would be quite reasonable to do that in September,

on the basis of the data that I've seen so far, even with the potentially lower

inflation data," he said.

     Evans, who is a voter this year on the FOMC, continued, "I do think if we

were to do that in September, we could do that and we could decide not to raise

the funds rate in September. That presumably takes us to December, unless the

data and the forecast change dramatically, which I don't expect."

     When it comes to December, when the FOMC will once again update its

economic forecasts and Chair Janet Yellen will have a press conference, Evans

said "I think that's many more months of inflation data and continued assessment

of the economy, which I expect to continue to grow in nice fashion for the

foreseeable future," Evans said.

     "So really it's the inflation monitoring," he said. "And I think that would

lead to good discussion in December" about whether another rate hike is

appropriate. 

     This is in line with the median forecast of the FOMC at its June meeting,

which anticipates one more rate hike will be appropriate this year.

     With continuing to improve labor market conditions and GDP growth

rebounding in the second quarter, Evans, like many of his FOMC colleagues, is

laser focused on inflation.

     "I think inflation weakness recently does raise the question ... How well

are we doing in getting inflation back to our 2% objective?" he said.

     Overall, though, Evans sounded confident the weaker than expected inflation

readings so far this year will prove to be temporary. "I think the inflation

data has been sufficiently unusual," he said, that the factors weighing on

inflation "would be expected to be one off and temporary and recede."

     Evans said he agreed with Yellen who said last month the recent lower

readings on inflation "have been driven significantly by what appear to be

one-off reductions in certain categories of prices," and that the Fed's policy

is still supportive of a return to 2% inflation.

     Yellen also said the FOMC policy is supportive enough to keep inflation on

track for to increase to the 2% objective over the next few years, "and I think

that is a reasonable expectation," Evans said.

     "Part of my concerns are that we've had this type of forecast for a while,

so I would like to see a little more evidence that we're getting to 2% sooner

rather than later," he said. Still he's not ready to pull a rate hike in

December off the table.

     One reason is that monetary policy is "currently still accommodative," he

said, though he added there is a "fair discussion" to be had about just how

accommodative policy is right now.

     Another area Evans sounded optimistic was for continued strong GDP growth.

He called second quarter GDP growth "good," adding it was still above his

expected forecast of longer-run trend GDP growth of about 1.75%.

     Plus, he expects the higher than trend growth to continue throughout the

second half of the year.

     With the announcement of the Fed's plans to end reinvestments nears, Evans

said he does not "expect any substantial market reaction from our choice to do

that." This is because the plan has been "well choreographed."

     He also doesn't "think the balance sheet adjustment is going to make a lot

of difference to financial conditions in the near term." 

     Once the FOMC plan to reduce reinvestments gets underway, Evans said he

expects it will take "three to maybe four years for the balance sheet to get to

appropriate size."

     However, the ultimate appropriate size of the balance sheet over the longer

term is an issue still to be settled. "There continues to be discussions about

what the future policy environment will be," he said, adding the FOMC expects to

find out more about financial markets will react to the different ways the Fed

can control monetary policy in the future.

--MNI Washington Bureau;tel: +1 202 371-2121; email: karen.mracek@marketnews.com

[TOPICS: MMUFE$,M$U$$$,MT$$$$]