US Fed hears inflation alarm bells ringing

Surprisingly high US consumer inflation data for April released this week lit a fire under top Federal Reserve officials, who came out swinging today against any inflation threat.

"Containing inflation has to be our primary focus," said Richmond Fed President Jeffrey Lacker -- comments that immediately tilted financial markets toward a rate hike at the June 28-29 Federal Open Market Committee policy meeting.

Lacker was the first Fed official to address the inflation issue since what many economists and traders saw as an uncomfortably high reading on core consumer prices on Wednesday.

"The inflation outlook right now is at the borderline of acceptable, and perhaps even beyond," Lacker, a voting member of the central bank's FOMC this year, told reporters after speaking to the Conference of State Bank Supervisors in Norfolk, Virginia.

St Louis Fed President William Poole, a non-voting FOMC member this year, later said that "an environment of clear inflation risks" exists, even though he expects contained inflation and healthy growth.

Lacker said he had been disappointed with the last two monthly reports on consumer prices, which both showed core prices -- stripped of food and energy -- up 0.3 per cent.

With crude oil prices still near US$70 ($113.98) per barrel, the Fed will be very focused on energy cost pass-through risks to core inflation in the months ahead, he said.

Earlier, Fed Chairman Ben Bernanke mostly steered clear of questions about the economy at a Chicago Fed conference on bank regulation, but said the housing market is "clearly weakening." "In combination with rising interest rates affordability is becoming much more difficult and therefore as you would expect you are seeing some cooling in those markets," Bernanke said.

The chairman's comments were consistent with ideas the Fed could soon pause its rate hikes ahead of an expected housing-led cooldown in the economy.

However, Lacker's remarks prompted a swift reassessment given that the FOMC said after its May 10 meeting that more rate hikes may be needed depending on "the evolution of the economic outlook as implied by incoming information." Chances of a Fed rate hike in June jumped as high as 60 per cent from less than 50 per cent earlier on Thursday.

The Fed had been expected by some analysts to lean on forecasts for slower growth as a way of ending two years of rate hikes even amid solid incoming data.

Some central bank officials have noted the lag between policy implementation and its effect on the economy, and warned of a possible "overshoot" on rate increases.

Poole appeared to question that notion.

"I myself place great emphasis on this point. Experience indicates that economic forecasts are not especially accurate and that means that monetary policy actions should depend on how the outlook changes rather than be decided in advance based on the forecast," he said.

"The important thing to focus on is how (Fed) policy depends on the data and the economic outlook," Lacker said.

The FOMC will get reams before its late June meeting, including one more look at the monthly CPI data, for May.

Commenting on the current slowdown in residential housing, Bernanke and Chicago Fed President Michael Moskow both noted dangers from the increased use of non-traditional mortgage products over recent years.

Up to 40 per cent of US home loans were of non-traditional types such as adjustable rate and no-money-down mortgages in 2005, Bernanke said.

"Some people will soon be faced with these (adjustable rate) loans re-pricing under less favorable conditions," Moskow said.

- REUTERS