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Fed's Dudley says rate hikes are appropriate to reduce the risk of overheating

Interest rate hikes are appropriate to reduce the risk of overheating, New York Fed President William Dudley said in prepared remarks on Thursday.

He argued that even after the central bank raised rates in March, the federal funds rate remains "unusually low."

"In such circumstances, it seems appropriate to scale back monetary policy accommodation gradually in order to reduce the risk of the economy overheating, and to avoid a significant inflation overshoot in the medium term," Dudley said in his remarks at the University of South Florida Sarasota-Manatee in Sarasota, Florida.

His comments come as markets are closely watching the Federal Reserve for insight into the number of interest-rate hikes investors can expect this year.

In its March meeting, the Fed said it still expects its federal funds rate to be about 1.4 percent at end of 2017. Traders tracked by the CME Group also seem to be pricing in two more rate hikes for the current year, with the next one coming in June.

While there are still "significant uncertainties and risks abroad," Dudley said that the economic outlook overseas "appears to have brightened" and that the risks are "significantly lower than they were a year ago."

Dudley, vice chairman of the policy-setting Federal Open Market Committee, said the U.S. economy "has continued to grow modestly above its sustainable long-term pace." He also said growth and inflation risks are both to the upside.

Fiscal policy is likely to become more stimulative, Dudley said. He added, however, that "there is still considerable uncertainty about fiscal policy and its potential contribution to economic activity."

Dudley said the Federal Reserve should gradually taper its reinvestments when it eventually reduces its balance sheet.