Fed's Mester sees U.S. rate hikes this year and next

By Jonathan Spicer

PRINCETON, N.J. - The Federal Reserve should continue raising interest rates this year and next so that it can avoid an overheating that cuts short the economic expansion that is already picking up steam, a policymaker of the U.S. central bank said on Monday.

Cleveland Fed President Loretta Mester, who leans somewhat hawkish, said the central bank can speed or slow its "gradual" policy tightening if, for example, recently announced U.S. tariffs on imports lead to a trade war that hits the economy.

Mester was among Fed policymakers who voted unanimously last week to raise rates by a quarter of a percentage point.

"If the economy evolves as I anticipate, I believe further gradual increases in interest rates will be appropriate this year and next year," Mester said in a speech at Princeton University. The Fed must "avoid a build-up in risks to macroeconomic stability that could arise if the economy were allowed to overheat," she added.

Mester, who earlier this year was under consideration by the White House to be the Fed's vice chair, sketched out a policy approach that appeared a bit more aggressive in the next couple years and less aggressive in 2020 than many of her colleagues.

Last week, the central bank lifted its expected policy path in a nod to large tax cuts and government spending and expectations that inflation should soon rise above a 2 percent target after years below it. Median forecasts see three rate hikes this year and next, and two more in 2020.

Mester, who was once a graduate student at Princeton, said U.S. tariffs on metals, planned tariffs on some Chinese imports, and the ongoing renegotiation of the North American Free Trade Agreement cloud the trade picture and pose risks to the economy.

The fiscal boost should lift GDP growth by 0.5 percent, or perhaps more, over this year and next, as the economy expands at a bit more than last year's 2.5 percent pace, she estimated.

Mester said she also updated her unemployment forecasts last week to reflect more labor-market slack than previously thought. The jobless rate stood at 4.1 percent last month.

(Reporting by Jonathan Spicer; Editing by Leslie Adler)