A top Federal Reserve official called on Thursday for a small interest rate increase by the end of the year if inflation rises as forecast, in one of the first outright calls from a policymaker to tighten monetary policy.

Under my baseline forecast, it would be desirable for the (Fed) to raise the fed funds target interest rate by a modest amount toward the end of 2011, Minneapolis Federal Reserve Bank President Narayana Kocherlakota said in remarks prepared for delivery to an economics conference.

Kocherlakota, a voter this year on the Fed's policy-setting Federal Open Market Committee, has been supportive of the central bank's ultra-loose monetary policy.

The Fed cut rates to near zero in December 2008 and has expanded its balance sheet to around $2.7 trillion in a further effort to support the economy.

Others on the Fed have said it might be possible for the central bank to raise rates later this year, while Kansas City Federal Reserve Bank President Thomas Hoenig has been alone with a call for rate hikes now. He has said the Fed should push rates up to 1 percent to avoid fueling an asset bubble.

Kocherlakota, in contrast, is the first policymaker to issue a specific tightening recommendation pegged to his economic outlook. Unlike Hoenig, Kocherlakota has been supportive of the Fed's aggressive easing policies.

He spoke to a conference in Santa Barbara, California, and his remarks were made available in Washington.

If his economic forecast pans out, a rate increase of around a half-percentage point would be warranted, Kocherlakota said. If his forecast proves off base, he said he would support a different policy path, depending on the strength of the recovery.

The Minneapolis Fed chief said he expects growth to pick up to between 3 percent and 3.5 percent over 2011. He envisions the jobless rate dropping slowly to between 8 percent and 8.5 percent by the end of the year. It was 8.8 percent in March and economists expect a report on Friday to show it held that level in April.

Inflation should rise from current low levels to around 1.5 percent as measured by the Fed's favored core personal consumption expenditures price index, which strips out volatile food and energy prices, he said.

Kocherlakota's forecasts for growth and core inflation are in line with projections from other Fed officials. However, he anticipates a bigger drop in the unemployment rate than the consensus of other officials.

If underlying inflation is higher than his forecast -- something the Fed will know in early fall -- Kocherlakota said he would call for a rate hike sooner. Conversely, if inflation were to fall relative to 2010, he said he would support further bond buying.

When the time comes to tighten financial conditions, the Fed could do so by shrinking its bloated balance sheet, either by halting reinvestments of maturing securities or selling assets outright, Kocherlakota said.

He added, however, that his preferred method to reverse easy money is to raise rates.

I have more confidence in that instrument of policy, Kocherlakota said. I suspect that confidence is shared by the public.

The Fed at a meeting last week said it is on track to complete its latest initiative of buying $600 billion in bonds through the end of June.

Fed Chairman Ben Bernanke said after the decision the Fed is in no hurry to tighten monetary policy given the modest economic recovery from a deep recession.

(Reporting by Mark Felsenthal; Editing by Padraic Cassidy and Dan Grebler)

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