Paul Davidson

USA TODAY

WASHINGTON-- Many Federal Reserve officials said the central bank may raise interest rates “fairly soon” and “potentially at an upcoming meeting” to head off a pickup in inflation, leaving the door firmly open to a March rate hike, according to minutes of the Fed’s Jan. 31-Feb. 1 meeting.

Fed policymakers said such a step could be necessary if the advances of the labor market and inflation were “in line with or stronger than their current expectations.”

The Fed also has started to discuss shrinking its $4.5 trillion balance sheet, a move that would mark a milestone in the 7 1/2-year-old economic recovery and could push up long-term interest rates.

Fed officials seem to be increasingly concerned that they may need to get ahead of accelerating inflation by nudging short-term rates higher sooner rather than later.

“A few participants noted that continuing to remove policy accommodation in a timely manner, potentially at an upcoming meeting, would allow the committee greater flexibility in responding to subsequent changes in economic conditions,” the minutes said.

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Among the chief reasons Fed officials foresee the possibility of faster growth and inflation is President Trump’s proposed infrastructure spending and tax cuts. Policymakers "continued to view the possibility of more expansionary fiscal policy as having increased the upside risks to their forecasts," the minutes said. But some officials also perceived risks of slower growth from some of Trump’s proposals, presumably restrictions on trade.

Several policymakers also said the risk of “undershooting” the Fed’s long-run unemployment target was “high, particularly if economic growth was faster than currently expected.” In that case, the Fed might have to raise rates more rapidly than anticipated to curtail inflation, bolstering the argument for lifting rates next month.

The meeting summary doesn’t necessarily mean the Fed will act at its mid-March meeting, but it seems to at least put the issue on the table. The Fed raised its benchmark short-term rate in December -- by a quarter percentage point to a still historically low range of 0.5% to 0.75% -- for just the second time in the past decade. Before the release of the minutes, fed fund futures put the chances of a hike at just 22% in March, 41% in May and 46% in June.

The Fed’s preferred inflation measure remains slightly below 2% but has been rising steadily. Meanwhile, the near-normal 4.8% unemployment rate is supplying employers a smaller pool of available workers and is expected to continue to hasten wage gains and inflation.

A “couple of” policymakers voiced concerns that the Fed’s vow to raise rates gradually “might be misunderstood as a commitment to only one or two rate hikes per year.” Fed officials have forecast three rate increases in 2017 and two to three annually over the next couple of years.

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At the same time, “many” policymakers “continue to see only modest risk” that the unemployment rate would substantially fall below the Fed’s target. And “a few” other Fed officials believe inflation is tame and see risks that could slow because of a strong dollar that’s likely to push down import prices.

Yet Fed policymakers also agree that they should soon begin discussions about the economic conditions that would warrant reducing the Fed’s $4.5 trillion balance sheet. During and after the 2008 financial crisis, the Fed bought $3.5 trillion in Treasury bonds and mortgage-backed securities in a campaign to hold down long-term interest rates.

Fed Chair Janet Yellen told Congress last week the central bank would begin to allow those assets to roll off its books after its key short-term rate is high enough that it can be lowered in response to economic turbulence. Reducing the Fed’s portfolio could set off some economic tremors by pushing up long-term rates.

Although the Fed provided no timetable for the move, the discussion at the meeting signified that the initiative may begin within the next year.