* Evans says would be okay with one more rate hike in 2017
* Fed seems likely to begin balance sheet cuts this year
* Fed may need to find ways to smooth reduction process (Adds quotes, details)
By John Geddie and Padraic Halpin
DUBLIN, May 12 (Reuters) - The Federal Reserve is likely to start reducing its balance sheet at the end of 2017 and may need to smooth out the process which could take three to four years, Fed policymaker Charles Evans said on Friday.
The U.S. central bank’s balance sheet has ballooned to near $4.5 trillion as a result of various monetary policy schemes to shore up growth and inflation following the financial crisis.
But with unemployment comfortably low at 4.4 percent and inflation just below the Fed’s 2 percent target, it has begun tightening policy by raising interest rates in recent years.
Evans, who is the Chicago Federal Reserve Bank President, told a conference in Dublin that at least one more hike should follow over the course of the year and that it seemed likely the central bank would start to reduce its balance sheet.
“It would be reasonable to have an amount that you would take out of the balance sheet each month that would be digestible for the (U.S.) Treasury,” Evans said.
“Making sure that the path of the balance down is gradual but sufficient to get to a more normal level before too long, say within three to four years.”
Evans said a normal size for the balance sheet would be “substantially above” the $800 billion seen in 2007 because the U.S. economy had grown since then.
The central bank is currently reinvesting proceeds of bonds it bought at the height of the crisis, so putting a halt to that would be one way to naturally reduce the balance sheet.
But Evans said monthly redemptions vary and that the Fed must be wary of creating distortions in financial markets.
”The quantities of maturing proceeds are going to be very uneven month to month, so in my opinion we might be well served by smoothing out this maturing proceeds and to make sure it’s a little more in line with what the markets can digest easily.
“We could go slower and figure out maybe that the markets have more of a capacity,” he said.
Evans said he would be “very surprised” if the Fed raises interest rates more than twice more this year.
“If inflation is confidently headed back to 2 percent, I could see two more rate increases this year,” Evans, a voting member of the policy-setting committee, said. “I could be okay with one as well if there are more uncertainties about the inflation outlook.”
Earlier, he said he believes “downside risks” predominate on the inflation front but that central bankers had to be wary of tax plans by U.S. President Donald Trump that could overheat the economy.
“There are theories that inflation could break out and they tend to be more about cutting-edge fiscal theory,” Evans said. “It does offer challenges if the fiscal situation takes off in a way that deficits lead to higher inflation; then we have to be quite nervous and look out for that.”
“I‘m not saying it’s going to happen; I don’t think it will happen, but we need to be mindful of the risks on both sides,” he added. “At the moment I think the downside risks still predominate.” (Editing by Catherine Evans)