Fed’s Hoenig: Don’t wait too long to raise rates

DURANGO, Colo. (Reuters) –

The Federal Reserve must not

wait too long before raising interest rates or it risks a

serious problem with inflation, one of its top policy-makers

said on Wednesday.

“While the current accommodative stance of monetary policy

reduces the risk of recession, it almost certainly raises the

risk of higher inflation,” said Thomas Hoenig, president of the

Federal Reserve Bank of Kansas City.

“It will be important for the Federal Reserve to monitor

inflation developments and inflation expectations closely, and

to move to a less accommodative stance in a timely fashion,” he

said in remarks prepared for delivery to an audience of

business leaders.

“When to begin this process, and how fast to move, will be

difficult decisions for the Federal Open Market Committee,” he

said, referring to the Fed’s interest-rate setting committee of

which he is a member, although not a voter, this year.

“While a two percent federal funds rate may be appropriate

in a period of extreme economic weakness, if maintained for too

long it could allow inflationary pressures to build over time,”

he said.

The Fed last month paused an aggressive rate-cut campaign

and left its key overnight benchmark funds rate at 2 percent,

warning at the time that inflation risks have mounted even as

risks to the economy from a housing crisis remain serious.

Since then, stock markets have been battered by worries

over the banking sector and the health of government-sponsored

mortgage finance giants Fannie Mae (FNM.N) and Freddie Mac

(FRE.N) on fears of home loan losses.

Hoenig acknowledged that problems in the banking sector

were making it harder to get credit and this was a restraint on

growth, which he expected to be only subdued — but still

positive — over the rest of 2008.

“While I believe we can avoid a recession, I recognize that

there are significant risks that growth could turn out weaker

than I suggest here,” he said.

This has created a “fine line” for the Fed to walk between

sheltering growth and keeping inflation at bay amid soaring

energy and food prices. Hoenig, generally counted among the

more hawkish Fed policy-makers, made plain that he erred more

towards fighting inflation.

“If an inflation psychology becomes embedded in household

and business behavior, this current rise in food and energy

prices could lead to a much more persistent inflation problem,”

he said.

(Editing by James Dalgleish)