The U.S. economy is facing an unwelcome disinflation, but bold policy action will restore growth in the second half of this year, Federal Reserve Bank of Cleveland President Sandra Pianalto said on Wednesday.

We are addressing large and complex problems, and we are extending and expanding our programs as necessary. I am convinced that more progress must be made, and that more progress will be made, Pianalto told a business audience.

She is not a voting member of the Fed's monetary policy-setting committee this year.

The United States entered a recession in December 2007 and the Fed has already cut interest rates virtually to zero and pumped hundreds of billions of dollars into financial markets to prevent a Japan-style widespread deflation taking hold.

That had accompanied a decade of stagnation in Japan and some fear the United States is at risk of the same fate.

My baseline projection is for real gross domestic product to decline sharply in the first half of 2009, followed by a modest upturn in the second half of the year. In this scenario, unemployment rates would likely continue to rise through the end of the year, she said.

But Pianalto insisted that the U.S. central bank's actions were gaining traction and noted they had already helped lower mortgage borrowing costs that should aid the housing market, which she said was a precondition to ending the recession.

Our actions are a vital part of the national economic recovery program. We are taking bold steps to put the credit markets back into good working order, and to support an increase in bank lending, she said.

U.S. President Barack Obama on Tuesday signed a $787 billion economic stimulus law to boost growth through spending and tax cuts. It also reinforces a $700 billion bank rescue plan drawn up by his Republican predecessor, George W Bush.

This has been severely criticized for pumping capital into banks without generating any promised increase in lending. But Pianalto said it was essential that the government not push banks into making bad loan decisions.

Pressuring banks to make imprudent loans ... is why we find ourselves in some of the circumstances we find ourselves in today, she told the audience in response to a question. We want banks to lend in a safe and sound manner.

(Writing by Alister Bull; Editing by James Dalgleish)

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