WASHINGTON (Reuters) -- Core U.S. inflation is likely to drop to 2 percent from about 2 1/4 percent, but pushing it below that may require higher interest rates, Federal Reserve Governor Frederic Mishkin said on Friday.
"I am less optimistic about the prospects for core PCE inflation to move much below 2 percent in the absence of a determined effort by monetary policy," Mishkin said in remarks prepared for delivery to a conference organized by the Federal Reserve Bank of San Francisco.
Mishkin was referring to a favorite inflation gauge of the U.S. central bank - the 12-month change in the government's Personal Consumption Expenditures index with volatile food and energy costs set aside.
An advance text of Mishkin's remarks was distributed to reporters in Washington.
Mishkin said he is "reasonably optimistic" that core inflation will drift down. But the process will take a while because of the recent rebound in prices for gasoline and petroleum products, he said.
Higher fuel prices have boosted the costs of many goods and services and as firms pass costs along to customers, monthly core inflation readings will be higher than they would otherwise be, he added.
Meanwhile, Mishkin said he believes long-term inflation expectations are currently anchored at a level not far below the current rate of inflation, and bringing them down even lower would be challenging.
"A substantial further decline in inflation would require a shift in expectations, and such a shift could be difficult and time consuming to bring about," Mishkin said.
Pushing inflation expectations lower might require holding interest rates up at a level that would lead to slower economic growth and higher unemployment, he said.
"The historical record suggests that permanently lowering inflation expectations may require keeping monetary policy tight for a substantial period, resulting in considerable output and employment losses for a time," he said.
Mishkin's remarks on inflation come two days after a statement from the Fed's policy-setting committee that many took to be a step away from an inclination toward raising interest rates if necessary to bring inflation down.
While the Fed's statement on Wednesday specified inflation as its "predominant" concern, it omitted a reference to the possibility of "additional firming" that recurred in previous statements. Instead, the U.S. central bank mentioned only "future policy adjustments."
Financial markets interpreted this as a shift toward a Fed policy that was just as likely to make lowering rates the next move as raising them. It came at a time when turbulence in the housing sector and stock market appear to have put U.S. economic growth on a shakier footing than at the beginning of the year.
Stocks and bond prices rallied on the Fed's statement on the belief the Fed would lower interest rates before the end of the year.
However, Mishkin's remarks suggest not all policy-makers have abandoned the thought of raising interest rates, if core inflation does not fall to within the 1 percent to 2 percent range that some officials have described as a comfort zone.
Core PCE in February was 2.3 percent higher than 12 months earlier, up slightly from 2.2 percent in January.
"At the Federal Reserve, we understand the importance to the health of our economy of anchoring inflation expectations," Mishkin said in his prepared remarks.
The Fed is willing to make "preemptive strikes against both inflationary and deflationary pressures," among other steps, to ensure price stability, he added.
Fed Chairman Ben Bernanke is due to testify before Congress on Wednesday about the Fed's recent statement and problems in U.S. mortgage markets.
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