Fed's Fisher sees rate hikes early next year, or sooner

LOS ANGELES (Reuters) - The Federal Reserve should allow its massive balance sheet to begin to shrink in October, a move that would signal a start to interest-rate hikes early next year, if not before, a top Fed official said on Wednesday.

The Fed already plans to stop its bond-buying stimulus in October, but has said it then expects to wait a "considerable time" before raising rates in order to avoid short-circuiting what has been a very slow recovery.

Many Fed officials, wary of any move that could send market rates higher before the economy is ready, want to continue to top up the U.S. central bank's $4.3-trillion balance sheet by reinvesting the proceeds of maturing bonds until or even after rate hikes begin.

But in the view of Dallas Fed President Richard Fisher, in a speech sure to burnish his hawkish reputation, the Fed risks stoking future inflation by keeping monetary policy too loose for too long. Fisher is a voting member this year on the Fed's policy-setting panel.

"Reducing our reinvestment of proceeds from maturing securities would be a good first step for the markets to more gently begin discounting the inevitable second step: that early next year, or potentially sooner depending on the pace of economic improvement, the (Fed) may well begin to raise interest rates in gradual increments, finally beginning the process of policy normalization," Fisher said in remarks prepared for delivery to the University of Southern California.

The Fed has kept interest rates near zero since December 2008 and has bought trillions of dollars of bonds to push down long-term borrowing costs and boost the economy. Fisher has long opposed the bond-buying, but this year has not dissented from the majority of his colleagues who support it because they have gradually been winding the program down.

Now, with unemployment falling faster than expected and inflation rising back toward the Fed's 2-percent target, the Fed is nearer to its goals than many appreciate, Fisher said. And while he would be willing to tolerate inflation rising temporarily above 2 percent, he said, "the notion that 'we can always tighten' if it turns out that the economy is stronger than we thought it would be or that we've overshot full employment is dangerous."

Instead, he urged, the Fed should "dilute the punch" of easy monetary policy.

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Fisher acknowledged his views are "increasingly at odds" with those of some of his colleagues. Fed Chair Janet Yellen this week reiterated her view that labor markets are far from healthy and the economy still needs considerable support from the Fed.

(Reporting by Ann Saphir; Editing by Chizu Nomiyama)