Fed's Harker says two rate hikes 'appropriate' this year

By Jonathan Spicer and Howard Schneider

PHILADELPHIA (Reuters) - Weak wage growth and possible risks in the bond market mean the Fed should slow its pace of rate hikes for now, Philadelphia Federal Reserve Bank President Patrick Harker said on Friday, adding the central bank should probably move just twice in 2018.

Even amid low inflation most central bankers have pencilled in three rate increases for the year, and Harker as recently as November said he also felt three quarter-point hikes would be appropriate.

But on Friday he shifted gears, signalling the growing concern at the Fed over continued weak inflation, as well as a newly emerging risk that continued Fed action may push short term interest rates above long term ones.

Such a situation, known as an inversion, has historically signalled the onset of recession, and Harker joined St. Louis Fed President James Bullard in flagging that as a possible problem.

The spread between short-term government securities and the 10-year bond, currently about half a percentage point, has been narrowing as the Fed has raised its target rate, and Harker said that may mean the Fed should slow down.

"I don't think we should do anything to precipitate an inversion," Harker said. "We have got some time."

Though unemployment has fallen to 4.1 percent, below what many economists see as full employment, wages have failed to pick up strongly and inflation weakened rather than gained over the course of 2017.

"It would be helpful if we would get inflation not just at two percent but above it for a while," Harker said. "It is okay to overshoot it."

In remarks prepared for delivery at the annual American Economic Association, he said he expects the economy to grow a bit below 2.5 percent in 2018, with only a slight increase of 10 to 20 basis points added as a result of the tax legislation approved in December. He forecasts unemployment will stay low this year before rising a few tenths of a percentage point next year, and inflation to push above 2 percent in 2019 before coming back to the Fed's target in 2020. There is "little slack" left in the labour market, he said.

But, he said, "if soft inflation persists, it may pose a significant problem," including making it more difficult to bring inflation back to target.

(Reporting by Ann Saphir and Jonathan Spicer; Editing by Chizu Nomiyama)