UPDATE 2-Fed's Lacker sees U.S. recession ending this year

(Adds details from question and answers, press briefing)

By Mark Felsenthal and Emily Kaiser

WASHINGTON, May 8 (Reuters) - Signs of recovery in consumer spending and housing support the conclusion the U.S. economy may emerge from its worst recession in decades by the end of the year, Richmond Federal Reserve President Jeffrey Lacker said on Friday.

"While economic activity is still contracting overall, some spending components appear to be bottoming out and the overall rate of contraction is thus slowing," Lacker said in a speech to the Washington D.C. Chamber of Commerce.

"If the emerging stability in housing and consumer spending persists, as I expect, some segments of business investment spending should bottom out by the end of the year and economic growth would then turn positive," he said.

But Lacker also cautioned that once the recovery is firmly in place, the U.S. central bank's policy-setting committee will need to shrink its swollen balance sheet in order to prevent a spike in inflation.

"Choosing the right time to withdraw that stimulus will be a challenge, and I believe it will be very important to avoid the risks of waiting too long or moving too slowly," he said.

Lacker noted there was much debate about whether inflation or deflation posed the biggest threat. He said he personally thought the risk of deflation was overstated, and the Fed should keep its focus on the public's inflation expectations.

As long as people think inflation is in check, that should anchor inflation in the near term. Still, he said concerns that the rapid expansion of the Fed's balance sheet would spawn inflation were "quite legitimate."

Gauging when policy-makers need to pull back on monetary policies aimed at stimulating growth is one of the hardest challenges they face, Lacker said.

"It's one of the most difficult and challenging problems in applied monetary economics," he told reporters after a speech to business leaders.

Lacker also said if the pace of U.S. job losses did not moderate, the recovery would be more sluggish.

Data released on Friday showed U.S. non-farm payrolls fell 539,000 in April. While job losses were substantial, they was the smallest in six months and less than economists had expected.

Lacker told the business leaders he was encouraged by the data.

The Richmond Fed head declined to comment on the resignation of the head of the board of the New York Fed, Stephen Friedman.

Friedman, who chaired the New York Federal Reserve's board of directors, resigned on Thursday amid questions about his purchases of stock in his former firm, Goldman Sachs (GS.N).

Friedman said he quit to prevent criticism about his stock buying from becoming a distraction as the Fed battles a severe recession. (Additional reporting by Lucia Mutikani, Editing by Chizu Nomiyama)