Fed's George: delay in bond tapering could hurt Fed credibility

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WASHINGTON (Reuters) - The failure of the Federal Reserve to begin scaling back bond buying at its meeting last week surprised financial markets and could undermine the effectiveness of its policies in the future, a top U.S. central banker said on Thursday.

Kansas City Federal Reserve President Esther George, an outspoken policy hawk who was the sole dissenter at the Fed's September 17-18 policy committee meeting, said that she had been disappointed by the majority's decision.

"Delaying action not only allows potential costs to grow, it also has the potential to threaten the credibility and the predictability of future monetary policy actions," she told the Colorado Economic Forum at a dinner in Denver.

"Policy moves that surprise the market often result in additional volatility."

George has dissented at every meeting this year against the Fed's massive bond purchase program, which she warns could lead to asset bubbles and inflation in the future.

Financial markets were stunned by the decision of the policy-setting committee last week to keep buying bonds at a monthly pace of $85 billion.

That contradicted clear signals all summer from Fed officials that they were getting ready to begin scaling back the program, marking the beginning of the end to an unprecedented five years of ultra-easy monetary policy.

George cautioned that this delay could lead financial markets to doubt the strength of the U.S. economy.

"Markets might misconstrue the postponement of action as reflecting a Committee assessment that the broader economic outlook is substantially weaker, when that is not the case."

On the contrary, she viewed the durability of U.S. growth and hiring in the face of Washington budget cuts as encouraging.

"The labor market and the broader economy have continued to improve in the face of fiscal tightening. I interpret this resilience as a signal that the economy's underlying fundamentals have improved substantially," she said.

Furthermore, by surprising investors, the Fed could sap confidence in its own forward guidance, that it will hold interest rates near zero until unemployment hits 6.5 percent, provided the outlook for inflation stays under 2.5 percent.

"Failing to adjust purchases at the last meeting, however, could risk the credibility and strength of these thresholds," she said. The U.S. unemployment rate was 7.3 percent in August.

(Reporting by Alister Bull; Editing by Paul Simao)