Fed must take steps to contain inflation: Plosser

NEW YORK Thu Jun 12, 2008 12:35pm EDT

NEW YORK (Reuters) - Philadelphia Federal Reserve President Charles Plosser on Thursday said current U.S. interest rates are supportive for growth, but the Fed needs to stay vigilant in keeping inflation expectations contained.

"Monetary policy is quite accommodative right now," Plosser told CNBC television. "Inflation is on everybody's mind ... We have to take appropriate steps to do something about that."

Plosser, a voting member of the Federal Open Market Committee this year, voted against the Fed's last two rate cuts. The central bank's rate-setting panel next meets on June 24-25.

U.S. consumer inflation expectations, which Fed policy-makers monitor closely, have risen sharply this year to levels not since the early 1980s amid surging oil prices. Retail gasoline prices topped $4 a gallon for the first time ever last week.

"We can't control the price of oil directly. We can control the underlying inflation pressures for the economy," he said. "Once those inflation expectations break out it's too late. We need to act preemptively to make sure they are contained."

Asked when the Fed will raise rates, Plosser said, "The timing when we do that is uncertain."

U.S. rate futures suggested about a three-in-four chance the FOMC will leave the key federal funds target rate at 2 percent at its meeting later this month. They implied traders see the Fed lifting it to 2.75 percent by year-end.

On the dollar, Plosser said he did not think it played a bigger factor in determining Fed policy, in the wake of recent remarks from Fed and Treasury officials aimed at propping up the greenback.

He said a weak dollar offers signal a on the stance of monetary policy and prospects for inflation. But he does not view a weak dollar in itself as causing inflation.

"I always think of the dollar reacting to inflation, rather than causing inflation," he said.

Plosser's remarks on interest rates and inflation spurred a round of selling in U.S. Treasury bonds. Benchmark U.S. 10-year notes were last down 25/32 in price for a yield of 4.17 percent, its highest level since late December.

He said the Fed needs to be sure that its series of rate easings, aimed at addressing the stresses in the financial sector and credit markets, do not become inflationary.

The Fed's rate cuts and various lending programs to banks and Wall Street dealers, while beneficial in containing the financial crisis, carry other potential risks, he said.

"As we extend the safety net, we create moral hazard," Plosser said.

The Fed must examine ways such as regulatory changes to deter investors and financial institutions from taking excessive risks, which led to the global credit crunch.

In the meantime, credit markets, while not out of the woods, have shown signs of improvement, Plosser said.

"We are going to see some bumps along the way before all of this is over," he said. "More broadly speaking I'm more encouraged than I was six weeks ago."

When asked about tax rebate checks sent to consumers, Plosser said, "In my view, I'm not counting on them to have a substantial impact on the economy, but it may have a modest impact in Q2 and Q3."

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