The U.S. central bank must resist popular pressure to keep interest rates too low as the economy recovers, according to a top Federal Reserve official.

Kansas City Federal Reserve President Thomas Hoenig, in remarks at a private meeting last month that were released on Saturday, also said that top U.S. banks were still too highly leveraged, and would evade demands to raise more capital.

As we become more confident that we are at the bottom of the recession and are moving into recovery, we must become more resolute in systematically reducing our balance sheet and raising interest rates, Hoenig told the annual meeting of the Kansas Bankers Association on August 6.

The Fed has cut interest rates to almost zero and doubled its balance sheet to around $2 trillion to keep credit markets from seizing in panic after investment bank Lehman Brothers failed last September amid massive losses on mortgage debt.

Moving from zero to one percent, for example, is not a tight policy. I don't know what the neutral rate is, but I am certain it isn't zero, Hoenig said.

Neutral refers to a level of interest rates that neither stimulates nor hinders growth. The Fed reiterated at its August 12 policy meeting that the weak economy would warrant exceptionally low interest rates for an extended period.

Hoenig, who is regarded as one of the Fed's most hawkish, or anti-inflation officials, will be a voting member of its policy-setting committee next year.

We are carrying more debt than we have carried in most of our history, and the pressure to keep rates low is only going to increase as the economy begins to recover, he said.

Hoenig said mixed signals from the economy indicate that the bottom of the recession had been reached, but predicted only a gradual recovery as businesses and households work off the consequences of the collapse of the U.S. housing market.

In this environment, one of the Federal Reserve's major challenges will be how to pull back its highly accommodative monetary policy without undermining the recovery and without igniting inflationary expectations, he said.

Hoenig's speech was on the implications of leverage and debt. He said that the country's 20 largest banks had far less equity capital than their smaller rivals, controlling $12 trillion in assets but supported by just 3.5 percent of equity capital versus 6 percent for the next 20 largest firms.

Some proposals being offered would require large institutions to hold more than this level of capital, he said, referring to the 6 percent threshold. I would suggest such proposals are wishful thinking and will not be achieved.

(Reporting by Alister Bull, editing by Vicki Allen)

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