The Federal Reserve should not wait too long to exit its extraordinary support for financial markets or risk sowing the seeds of the next crisis, a top Federal Reserve policy-maker said on Thursday.

The U.S. economy appears to be in the early stages of recovery, labor market conditions have begun to stabilize and the housing market shows signs of recovery, Federal Reserve Bank of Kansas City President Thomas Hoenig told a conference in Kansas City. Uncertainty remains, however, and short-term inflation risks are likely small, he said.

The Fed cut interest rates to near zero in December 2008 and created a host of emergency lending facilities to fight the worst recession in more than 70 years. It has pledged low rates for an extended period.

Maintaining excessively low interest rates for a lengthy period runs the risk of creating new kinds of asset misallocations, more volatile and higher long-run inflation, and more unemployment -- not today, perhaps, but in the medium and longer run, Hoenig said.

Hoenig, who is seen as one of the more hawkish, or anti-inflationary, policymakers at the U.S. central bank, is a voting member of the Fed's rate-setting committee this year.

Maintaining short-term interest rates near zero could actually impede the recovery process in financial markets, he said.

While there is considerable uncertainty about the outlook, the balance of evidence suggests that the recovery is gaining momentum. In these circumstances, I believe the process of returning policy to a more balanced weighing of short-run and longer-run economic and financial goals should occur sooner rather than later, Hoenig said.

(Reporting by Kristina Cooke; Editing by James Dalgleish)

Inflation