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Former Fed governor: Rates will rise at turn of the year

Investors pricing in a federal funds rate hike in mid-2015 could get caught off guard, former Federal Reserve Governor Robert Heller told CNBC on Wednesday.

"I think that's what the current Federal Reserve Board thinks will be the right time," said Heller, referring to expectations of a rate rise in mid-2015.

(Read More: One thing Yellen could say that would worry markets)

"I still think markets will force the Fed to tighten a little bit earlier than that. So it may well happen around the turn of the year as we approach 2015, that is also around the time that the tapering operation should be finished," he added.

Janet Yellen, the new Federal Reserve Board chairwoman, appears before the House Financial Services Committee on February 11, 2014 in Washington.
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Janet Yellen, the new Federal Reserve Board chairwoman, appears before the House Financial Services Committee on February 11, 2014 in Washington.

The Federal Reserve has kept its benchmark interest rate near zero since 2008, when a global financial crisis that plunged financial markets into turmoil.

As the Fed now unwinds its massive stimulus program and the U.S. economy recovers, markets anticipate an interest rate increase to follow not too long after the end of tapering. Analysts are divided over how long the full unwinding of stimulus will take; some expect it to wind up this year, while others expect it to extend into next year.

According to Heller, as investors become more bullish about the domestic recovery, yields on U.S. government bonds will be pushed higher, encouraging the Fed to follow suit.

"If markets become more convinced that more inflation is coming, and the economic situation is good over all, they will take rates higher and they should be higher. We should be able to live with 4 to 4.5 percent interest rates for the 10-year Treasury at the present time. So I think an increase in rates is entirely appropriate," he added.

(Read More: US economy should be growing at 3-4%: Former Fed governor)

He added that recent weak U.S. economic data can largely be blamed on extreme weather conditions, but he was concerned that the government would prove a hindrance to the overall recovery by introducing further regulations and creating uncertainty for investors.

Heller's comments come ahead of newly appointed Fed chair Janet Yellen's first Federal Open Markets Committee meeting on Wednesday.

By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie

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