The U.S. jobless rate will probably not rise to levels reached during the recession of the early 1980s and is likely to crest above 9 percent before declining, St. Louis Federal Reserve President James Bullard said on Friday.

I'm hopeful that we will stay under the peak hit in 1982, 10.8 percent, he told reporters after speaking to the Arkansas Bankers Association.

Bullard said one of the Fed's main goals in the coming year should be to avoid falling into a vicious cycle of falling prices causing consumers and businesses to pull back, bringing prices down further, a deflationary trap like Japan experienced in the 1990s.

However, he said that in the medium term, it is very important for the U.S. central bank to have a plan in place to pull back the vast amounts of liquidity it has pumped into the economy to avoid a sharp rise in inflation when the economy rebounds.

You're sort of shooting the rapids here, he said.

Bullard said the harsh recession is likely moderating and expansion is possible in the second half of 2009 after several quarters of contraction.

We will see a less severe rate of decline in the second quarter and I'm hopeful we'll see some positive growth in the second half of this year, said Bullard, who is not a voter on the Fed's policy-setting panel this year.

The Fed said on Wednesday after a two-day policy meeting that the outlook for the U.S. economy had improved a bit in recent weeks but that low interest rates would be needed for some time to ensure it recovers from recession.

The U.S. central bank held benchmark overnight interest rates in the zero to 0.25 percent range reached in December even as officials took stock of some recent hopeful economic signs.

Although the economic outlook had improved modestly since the March meeting, partly reflecting some easing of financial market strains, economic activity is likely to remain weak for a time, the Fed said.

Data released on Friday provided more signs of a bottoming out of the U.S. economic slide. The U.S. factory sector shrank at a slower pace in April, and consumers felt more confident about the economy last month than at any time since September.

Discussing the likely overhaul of U.S. bank regulation in the wake of the worst financial crisis since the Great Depression, Bullard said the Fed needs to continue to regulate the largest banks to be able to monitor developments in the financial system.

The Fed's lender of last resort and monetary policy functions mean that it will have to remain closely involved in the regulatory structure, Bullard said in a speech to the Arkansas Bankers Association.

To improve supervision of large banks and non-bank financial firms, a credible resolution regime and improved monitoring are important, Bullard said.

The regulatory system has worked well for small banks during the crisis because it provides deposit insurance, high-quality monitoring of banks, and a clear, credible resolution regime, he said.

(Reporting by Mark Felsenthal; Editing by Andrea Ricci)

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