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May 26, 2015

Bumpy road ahead when Fed finally raises interest rates

Official: Expect some bouts of financial market volatility

When the Federal Reserve raises U.S. interest rates for the first time in nearly a decade, it should weigh the effects on global economies and can expect some bouts of financial market volatility, a top Fed official said on Tuesday.

"In the normalizing of its policy, just as when loosening policy, the Federal Reserve will take account of how its actions affect the global economy," U.S. Federal Reserve Vice Chairman Stanley Fischer said in Israel. "The actual raising of policy rates could trigger further bouts of volatility, but my best estimate is that the normalization of our policy should prove manageable for the emerging market economies."

Fed Chair Janet Yellen last week signaled the U.S. central bank is on track to raise rates this year, despite a weak first quarter that some analysts believe could force the Fed to wait longer before starting its first tightening cycle since 2004-2006.

Fischer gave no time frame for raising rates in the text of his remarks, but made it clear that higher rates are coming.

"Markets should not be greatly surprised by either the timing or the pace of normalization," he said, reiterating that the Fed will not raise rates until the labor market has improved further and policymakers are confident inflation is headed back to the Fed's 2 percent goal.

Still, he said, communications can be a "tricky business," and when the Fed does tighten, policymakers are bracing for spillovers to financial markets both at home and abroad.

Some of the world's more vulnerable economies "may find the road to normalization somewhat bumpier," said Fischer, a former Bank of Israel chief who prefaced his speech with remarks in Hebrew.

To smooth the way, he said, the Fed will communicate its view of the economy and its policy intentions "as clearly as possible."

If foreign economic growth is slower than anticipated, the Fed could raise rates more slowly than otherwise, he said.

"We are working to ensure that our financial institutions and other market participants are prepared for the normalization of monetary policy and the return to a world of higher interest rates," Fischer said. "It is equally important that individuals, businesses, and institutions around the world do the same."

(Reporting by Ari Rabinovitch; Writing by Ann Saphir; Editing by W Simon and Meredith Mazzilli)