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Fed's Dudley: Gradual path to rate hikes appropriate

Risks to the U.S. economy remain tilted to the downside, thus the Federal Reserve must maintain a cautious and gradual approach to raising interest rates, a key Fed official said Friday.

Caution is needed "because of our limited ability to reduce the policy rate to respond to adverse developments, recognizing that we could also use forward guidance and balance sheet policies to provide additional accommodation if that proved warranted."

New York Fed President William Dudley — a voting member of the central bank's policymaking committee — said in prepared remarks he expects the U.S. economy to grow about 2 percent in 2016.

"Although the downside risks have diminished since earlier in the year, I still judge the balance of risks to my inflation and growth outlooks to be tilted slightly to the downside," Dudley said.

He added inflation will fall short of the Fed's 2 percent goal and a decline in inflation expectations was possible. Dudley also said several sectors of the economy are showing signs of softness.

Low oil and commodity prices "may signal more persistent disinflationary pressures than I currently anticipate, while renewed tightening of financial market conditions could have a greater negative impact," Dudley said, while "there is significant uncertainty about economic growth prospects abroad."

Consumer spending has moderated while the manufacturing has rebounded, he said.

Dudley's remarks came a day after Fed Chair Janet Yellen touted the strength of the U.S. economy, saying she wouldn't describe it as a "bubble economy, citing a "healing" labor market and a 5 percent unemployment rate.

Recent economic data has been mixed, with the U.S. trade deficit widening in February and manufacturing data coming in better than expected.

Dudley also said there are still uncertainties about the effects of weak foreign growth on the U.S. On Tuesday, IMF Managing Director Christine Lagarde said global economic recovery continues, but remains delicate.

— CNBC's Jacob Pramuk and Reuters contributed to this report.