WASHINGTON (BLOOMBERG, REUTERS) - The Federal Reserve's consensus about when to shrink its balance sheet and how to approach policy strategy in a time of low inflation is starting to fragment.

Fed officials continued to view gradual interest-rate increases as appropriate while starting the process of unwinding their US$4.5 trillion balance sheet this year, minutes from their June 13-14 meeting released in Washington on Wednesday (July 5) showed. But their debate highlighted divisions over the timing of roll-off and unease at recent weak readings on inflation.

"They don't understand why inflation is so low while they are nearing full employment," said Ms Julia Coronado, president of MacroPolicy Perspectives in New York.

Chairman Janet Yellen is trying to manage a deft exit from unprecedented policy stimulus without roiling bond markets or slowing growth. She is also keeping an eye on inflation as labour-market slack diminishes in what could prove her final year at the helm of the US central bank. Dr Yellen's current term expires on Feb 3 and President Donald Trump has not yet indicated if he would renominate her, or pick someone else.

US unemployment stood at 4.3 per cent in May, a 16-year low and well under the 4.6 per cent that officials estimate representing maximum use of labour resources. For some, such low levels of labour-market slack support their forecast that inflation will stabilise around the Fed's 2 per cent target.

So far, it has not. The annual change on the Fed's preferred gauge of price pressures was 1.4 per cent in May and the index has been almost continuously below their target more than for five years. The minutes noted that "most participants viewed the recent softness" in inflation indicators "as largely reflecting idiosyncratic factors". Fed officials' baseline outlook is that recent weakness in inflation "is transitory, but they have to formulate a plan if it isn't", Ms Coronado said.

That plan, according to one wing of the committee, would be to ease back on policy normalisation and wait for prices to rise.

"A few participants who supported an increase in the target range at the present meeting indicated that they were less comfortable with the degree of additional policy tightening through the end of 2018," the minutes said. "These participants expressed concern that such a path of increases in the policy rate, while gradual, might prove inconsistent with a sustained return of inflation to 2 per cent." The minutes also showed a split on policy strategy, with about half the committee now supporting a run-it-hot scenario for the labour market.

"Several participants endorsed a policy approach" where the labour market would undershoot their estimate of full employment "for a sustained period".

Meanwhile, several other participants "expressed concern that a substantial and sustained unemployment undershooting might make the economy more likely to experience financial instability or could lead to a sharp rise in inflation".

"The minutes from the June 13-14 meeting underscore that the start of the balance sheet reduction is on course for this year," Ms Kathy Bostjancic, head of US macro investor services at Oxford Economics, wrote in a note. "On the interest rate front, we believe rising concerns that the slowdown in the inflation rate could be long-lasting will lead policymakers to forgo additional rate hikes this year and to only raise rates twice (total 50 basis points) in 2018."

The policy committee was divided over when to start a gradual tapering off of its balance sheet, leading to no decision timing, minutes from the June meeting showed. "Several preferred to announce a start to the process within a couple of months," the minutes said. "Some others emphasised that deferring the decision until later in the year would permit additional time to assess the outlook for economic activity and inflation."

The minutes reasserted their intention to begin the process "this year, provided that the economy evolves broadly as anticipated". "It sounds like there is genuine disagreement over whether sooner or later is better," said Mr Guy Lebas, chief fixed-income strategist at Janney Montgomery Scott in Philadelphia.