By Michael S. Derby

NEW YORK (Reuters) – St. Louis Federal Reserve President Alberto Musalem stated on Wednesday that he anticipates the U.S. central bank will continue to cut interest rates, though he remains cautious about prospective actions at its policy meeting later this month.

With inflation expected to gradually decline to the Fed's target of 2%, Musalem indicated that "additional easing of moderately restrictive policy toward neutral will be appropriate over time" at a Bloomberg monetary policy conference.

He emphasized the importance of policy flexibility, suggesting it may soon be time to consider either slowing the pace of interest rate reductions or pausing to evaluate the current economic situation, incoming information, and the evolving outlook.

Financial markets project that the Fed will reduce its policy rate by a quarter percentage point from the current 4.50%-4.75% range during its Dec. 17-18 meeting, in an effort to align policy with easing inflation and a more balanced labor market.

Musalem mentioned the need for more data before solidifying his stance on what should happen at the meeting, stating, "I'm keeping all my options open."

The longer-term policy outlook has become less certain following President-elect Donald Trump's recent election victory. Trump’s platform includes plans for import tariffs, the deportation of undocumented immigrants, and tax cuts, which could reignite inflationary pressures and affect the economic landscape.

While acknowledging that the "textbook" interpretation of tariffs suggests higher prices and lower demand, Musalem plans to consider government policy changes as they transpire, asserting that none of this uncertainty diminishes the central bank's capacity to continue making forecasts.

He further expressed that monetary policy is currently "well positioned" to respond to economic trends, asserting that the current restrictive stance aligns with core price pressures that remain above the Fed's 2% inflation target. He cautioned that "in the current environment, easing policy too much too soon poses a greater risk than easing too little, or too slowly."

Musalem suggested it could take up to two years to achieve the Fed's inflation target and that a patient monetary policy approach is warranted in light of the current inflation levels in a "strong" economy where the job market appears consistent with full employment.

He anticipates growth to taper towards the economy's long-term potential alongside further cooling of the labor market and moderate compensation growth. "I expect the labor market will remain consistent with full employment while the unemployment rate rises modestly toward estimates of its natural rate," he mentioned.

Additionally, he touched on the Fed’s ongoing initiative to decrease its balance sheet through quantitative tightening, which has seen its holdings shrink from a peak of approximately $9 trillion in the summer of 2022 to about $7 trillion now.

"I expect the balance sheet will continue to roll off," Musalem said. However, he acknowledged uncertainty around when liquidity could become overly constrained, remarking, "we're trying to find that point of transition. We don't know where that point is."