Fed officials say must be ready to curb inflation

By Alister Bull

ASPEN, Colo. (Reuters) - The U.S. Federal Reserve must be ready to take action if slowing economic growth fails to curb inflation stemming from higher food and energy prices, two top Fed policy-makers said on Tuesday, indicating that higher interest rates may be needed.

Richard Fisher, president of the Dallas Fed, and Jeffrey Lacker, president of the Richmond Fed, both of whom are known for their hawkish stances on inflation, warned that vigilance on price pressures is necessary even as oil prices have come off their peaks.

"Until we have a clear sense of what will prevail, monetary policy-makers must remain poised to act if slowing growth fails to contain inflationary pressures," said Fisher said.

Fisher is a voting member of the policy-setting Federal Open Market Committee this year and has dissented at every meeting so far in favor either of higher rates, or of less aggressive easing. He said is "very comfortable" with his a reputation as one of the most anti-inflation Fed officials.

Lacker, who is not a FOMC voter this year but dissented with the rate-setting group's majority decision in the past, echoed some of Fisher's comment in an interview with Bloomberg

TV.

"Unless the python that is the U.S. economy can quickly pass the recent burst of cost-push pressures, we risk a reinforcing spreading of inflationary impulses and expectations," Fisher told the Progress and Freedom Foundation in Aspen, Colorado.

"Should this happen and the Fed were to fail to address it, we would run the risk of losing the public's confidence in our ability to constrain inflation," he said.

INFLATION SURGE

Earlier Tuesday, the Labor Department reported that U.S. wholesale prices rose at the fastest annual rate in 27 years. Producer prices in July were up 9.8 percent from a year ago, the biggest increase since 1981, while prices excluding food and energy were up 3.5 percent, the biggest rise since 1991.

Fisher welcomed the recent decline in oil prices and said he was not surprised by the rise in the value of the dollar on foreign exchanges markets. A stronger dollar helps blunt rising import prices, but Fisher cautioned it was premature to conclude the currency's rise would keep inflation at bay.

"It depends on how sustained it is. ... It is a question of durability and I think it is too early to call," he told reporters after the speech.

Lacker, on the other hand, had a more upbeat assessment on inflation. "I expected overall inflation will moderate in the coming months," he told Bloomberg TV.

The Fed halted its aggressive rate cutting campaign in June after slashing its benchmark overnight fed funds rate 3.25 percentage points to 2 percent since mid-September to shield the economy from a housing crisis and credit crunch.

The Fed's current target rate is very low and may not be enough to deter prices from spiraling out of control, Fisher told the audience during a question-and-answer session.

Lacker also warned that current rates are "awfully low," which can risk fanning inflation higher.

Fisher said the Fed had "done its job on the growth front," although he warned the economy would slow to a snail's pace in the second half, if not grind completely to a halt, before a recovery unfolds in 2009 to take it back to trend growth.

FED'S BALANCING ACT

Fisher, while wary about inflation, acknowledged the housing and credit markets remained very fragile, subtly reinforcing market expectations that the Fed will keep rates on hold in the months ahead.

On the other hand, the Dallas Fed chief stressed that the central bank would be able to raise interest rates to ward off inflation without collapsing financial markets.

In addition to keeping rates steady, the Fed has continued to lend a sizable portion of its Treasuries portfolio to banks in a bid to keep funds flowing in the financial system. But he maintained these liquidity measures are temporary and will end "as soon as it is feasible."

While the banking sector has the public support from the Fed, the same could not be said for Fannie Mae and Freddie Mac .

Fisher refused to comment when asked by reports about the two struggling mortgage finance giants, whose shares have been pummeled this week on renewed worries about their ability to raise capital in the face of rising mortgage losses.

Lacker was more pointed in his view about their fate. He said he preferred to see them "credibly and demonstrably privatized."

(Additional reporting by Glenn Somerville and Richard Leong)

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