Fed's Yellen sees possible December rate rise, gradual hiking path

By Howard Schneider and Jason Lange

WASHINGTON (Reuters) - Federal Reserve Chair Janet Yellen on Wednesday pointed to a possible December interest rate "liftoff" but said rates would rise only slowly from then on to nurture the U.S. economic recovery.

In her first public comments since the Fed's meeting last week Yellen laid out what now appears the base case at the U.S. central bank - that low unemployment, continued growth and faith in a coming return of inflation means the country is ready for higher interest rates.

Her remarks pushed bond yields higher and stocks lower. They also caused investors to reset their expectations of a December rate hike above 60 percent, a sign that markets are finally taking the Fed's language seriously after a period in which U.S. central bankers were frustrated by the gap between their own outlook and market bets about their likely course of action.

"What the committee has been expecting is that the economy will continue to grow at a pace that is sufficient to generate further improvements in the labour market and to return inflation to our 2 percent target over the medium term," Yellen said at a House Financial Services Committee hearing.

"If the incoming information supports that expectation then our statement indicates that December would be a live possibility."

William Dudley, the influential president of the New York Fed and a permanent voter on policy, said later on Wednesday that he would "completely agree" with Yellen. December "is a live possibility, but we'll see what the data shows," he told reporters in New York.

Yellen, Dudley and the other 15 Fed policymakers now have six weeks to analyse new data, debate and decide whether at their Dec. 15-16 meeting to end the ultra-low interest rates set in response to the 2007-2009 economic crisis and recession.

Moving sooner rather than later to begin tightening policy, Yellen said, would allow the Fed to take a gradual approach to further hikes, slow enough to ensure that housing and other key markets are not disrupted by rising rates.

"Moving in a timely fashion - if the data and the outlook justify such a move - is a prudent thing to do because we will be able to move in a more gradual and measured pace," she said.

"It's been a long time that interest rates have been at zero, but markets and the public should be thinking about the entire path of policy rates over time. And the committee's expectation is that that will be a very gradual path."

As the central bank approaches the critical decision, there has been division at the highest levels over whether the time is right. Fed governor Lael Brainard has expressed among the deepest concerns about whether a weak global economy could damage the U.S. recovery, but on Wednesday struck a slightly more upbeat note.

"The improvement in the labour market has been extremely steady," Brainard said at a conference in Germany. "There are certain aspects of the U.S. outlook that are encouraging."

Both Brainard and Yellen emphasized that the Fed has not yet made a decision, and that incoming economic data would have to meet the central bank's expectations of how the economy is performing.

Another top Fed official, Vice Chairman Stanley Fischer, is scheduled to speak at a forum in Washington later on Wednesday.

"At the moment what we see is a domestic economy that is pretty strong and growing at a solid pace, offset by some weakening spilling over to us from the global economy," Yellen said. "On balance, as we said, we still see the risks to economic growth and the labour market as balanced."

(Reporting by Howard Schneider and Jason Lange; Additional reporting by Jonathan Spicer in New York; Editing by Andrea Ricci)