The U.S. recession is likely to end this year, but the Federal Reserve will not be in a rush to change its policy stance while unemployment is still rising, a top Fed policy-maker said on Wednesday.

I'm assuming that policy will continue to be accommodative for a considerable time, Chicago Fed President Charles Evans told reporters after a speech in South Bend, Indiana.

Evans was the latest policy-maker to cast doubt on ideas that the Fed could raise benchmark U.S. interest rates before the end of 2009 or in early 2010.

The Fed needs clearer signs of sustainable growth before starting to reverse course, Evans said. He forecast modest increases in output for the second half followed by somewhat stronger growth in 2010.

At this late stage in the economic cycle, Evans said more stimulus would be helpful but that it would be tough to identify fresh measures that the Fed could undertake.

Everybody is very nervous about the current situation and we're at a very difficult time. We're trying to judge if in fact the economy is closing to bottoming out. There's a large amount of nervousness and uncertainty associated with that.

Still, in his remarks to the Chamber of Commerce of St. Joseph County, Evans said the possibility that the economy is close to a turning point, is stronger now than just three months ago.

Evans, a voting member of the Federal Open Market Committee in 2009, suggested Fed policies -- regarding benchmark rates and on nontraditional credit easing programs -- are on hold.

In the absence of unexpected shocks and changes, I don't foresee the need for any major changes to the policy parameters of the programs, and I view us in a wait-and-see mode.

NO INFLATION FLARE-UP

Evans did not anticipate inflation flaring up in the short run given weak labor markets and low capacity utilization.

In particular, he said the U.S. jobless rate, which hit 9.5 percent in June, had risen more quickly than he expected and may not peak until some time in the first half of 2010.

The Fed traditionally has not raised interest rates while unemployment is still rising. Evans said the jobless rate was likely to peak above 10 percent, but below 10.6 percent.

With that level of slack in the economy, I think the downward forces on inflation will be greater than the upward forces, and we could see some declines in core inflation, Evans said. Inflation risks will become more balanced over the medium term, he added.

Evans said that recent economic data have been uneven but on balance consistent with the idea that the pace of contraction is slowing and that activity is bottoming out.

Improved conditions in financial markets, and stabilization in consumer spending and housing markets, are among the signs of improvement, he said.

In the months ahead, a turn in the inventory cycle as inventories better align with sales should translate into a net positive for GDP growth, Evans said.

SHRINKAGE

Evans said that some of the Fed's credit-easing programs will shrink as market conditions improve.

Still, a significant portion of the balance sheet will likely not shrink on its own, or at the appropriate pace, forcing the U.S. central bank to gear up its exit strategy.

We need tools to manage it actively, so that monetary policy can be more easily calibrated. In this respect, we can be as creative on the way out as we were on the way in, Evans said.

Some of those tools will include selling assets outright or through reverse repurchase agreements, and paying interest on reserves, he added.

Evans acknowledged the risk that the rapid increase in the Fed's balance sheet could trigger high inflation, but said there is no middle link in the chain that has led from central bank credit expansion to inflation in the past.

Inflationary pressures will not arise without broader credit expansion, and there is no evidence for that at present, he said.

Still, Evans noted that inflation, and survey-based measures of inflation expectations, have not fallen as much as might have been expected given the severe downturn.

As the economy improves, consumers and businesses might expect upward pressure on inflation, Evans warned.

Experience shows that a rise in inflation expectations, once solidified, becomes embedded in many economic decisions and makes inflation harder to control. He later told reporters he does not expect a rise in inflation expectations for now.

(Editing by James Dalgleish)

Inflation