FED FOCUS-Fed's cash deluge sows seeds of future US inflation

By Pedro Nicolaci da Costa

NEW YORK, March 11 (Reuters) - The U.S. Federal Reserve has flooded the financial system with money in an effort to lubricate rusty credit markets, but the attempt to shore up banks could translate into big cost increases for consumers.

The central bank announced on Tuesday it was pumping an additional $200 billion into financial markets and taking on riskier collateral as it became clear recent measures to stem the credit crisis had failed to have the desired effect.

A barrage of losses at financial firms, which by some estimates have already topped $200 billion, has triggered fears of a nasty U.S. economic recession, narrowing the Fed's options. Yet analysts say the urgent need for remedies on the part of policy-makers will not come without side effects.

"While the Fed strives to relieve the market's strains, the liquidity surge it has provided also is beginning to build a dangerous, longer-term inflation potential beneath the surface," warns Milton Ezrati, senior economist at Lord Abbett.

Ezrati argued that the excess cash in the financial system has not yet showed up in bank reserves statistics simply because the crisis itself has blocked traditional lending channels. Once the credit crunch eases, this liquidity could not only lead to new asset bubbles but also threaten America's hard-earned price stability.

"As anyone who can recall the great pain of the 1970s can attest, such excess liquidity can, if not checked, lead to a dangerous and destructive generalized inflation," he said.

STOP THE PRINTING PRESSES

At the moment, talk of possible bankruptcy by a major financial institution continues to swirl around Wall Street trading desks, making a stimulative monetary policy seem like the most prudent course of action.