Treasury selloff signals need to bolster Fed's inflation credibility, Musalem tells FT

July 31 (Reuters) - A selloff in U.S. Treasuries this week signaled the need for the Federal Reserve to earn its inflation-fighting "credibility" with interest rate increases, St. Louis Fed President Alberto Musalem told the Financial Times.

"At this juncture, earlier, incremental, gradual interest-rate action is preferable, less costly and less disruptive than potentially later, larger and abrupt actions," Musalem, who is not a voting member of the Federal Open Market Committee this year, told the FT.

Musalem, who sits on the rate-setting body, told the newspaper he had "expressed a preference" towards a quarter-percentage-point interest rate increase at this week's policy meeting, where the Fed left rates unchanged.

The interest rate decision and a hint from Fed chief Kevin Warsh that the central bank may look to change its inflation goal posts helped send 30-year Treasury yields above 5.2%, a 19-year high.

The widely expected decision to leave policy on hold drew dissents from three of the 12 FOMC members who wanted a quarter-percentage-point hike instead.

The three Fed officials who dissented expressed concern on Friday that without an immediate increase in short-term borrowing costs inflation will stay stuck above the Fed's 2% target, where it has been for more than five years.

Traders are betting a 67% chance on a 25-basis-point rate hike in September, according to CME Group's FedWatch tool.