Fed can consider trimming bond holding when key rate hits 1 percent - Harker

By Jason Lange

MALVERN, Pa. (Reuters) - The Federal Reserve can consider shrinking its massive trove of bonds once the interest rate on overnight lending between banks rises to 1 percent, Philadelphia Fed President Patrick Harker said on Thursday.

Harker's comments make him the second Fed policymaker this week to say cutting the balance sheet is now on the horizon, giving another signal the Fed could tighten monetary policy more aggressively under the Trump administration.

The U.S. central bank currently holds $4.5 trillion on a balance sheet mostly composed of government bonds but which also includes mortgage securities backed by U.S. taxpayers.

The Fed's balance sheet ballooned during and after the 2007-09 recession as the Fed bought bonds to lower rates. The Fed has said it would not shrink the balance sheet until a cycle of rate hikes is well under way, but Harker's comments suggest that day might not be far off.

"When we are at or above 100 basis points - and we are moving toward that - I think it is time to start serious consideration of first stopping reinvestment and then over a period of time unwinding the balance sheet," Harker, who has a vote on monetary policy this year, told reporters. He was referring to the fed funds rate for interbank lending which the central bank tries to guide.

Boston Fed President Eric Rosengren said on Jan 9 that the Fed should consider trimming the balance sheet, a move that could cool the economy by raising interest rates for longer-term loans like mortgages or corporate borrowing.

The overnight interbank rate currently stands at 66 basis points, which is within the Fed's current target range of between 50 basis points and 75 basis points. After holding rates near zero for seven years, the Fed raised rates in December 2015 and again in December 2016.

In a speech earlier in the day, Harker said the U.S. economy is gathering enough strength to warrant three interest rate increases this year. That would leave the fed funds rate above 1 percent by the end of 2017.

"The economy is displaying considerable strength," Harker told a business group in Malvern, Pennsylvania.

The Fed said last month the median forecast of its 17 policymakers was for three rate increases this year. Previously, policymakers saw two rate increases for 2017 and the steeper path of hikes was seen as a sign policymakers expect the economy will heat up because of fiscal stimulus under the administration of President-elect Donald Trump, who takes office on Jan 20.

Harker, however, said his rate outlook has yet to incorporate any possible fiscal stimulus.

(Reporting by Jason Lange; Editing by Chizu Nomiyama)