Inflation may require higher rates: Fed's Plosser

By Pedro Nicolaci da Costa

KING OF PRUSSIA, Penn. (Reuters)- Rising inflation could force the Federal Reserve to start raising interest rates even before labor and financial markets recover, one of the Fed's staunchest inflation hawks said on Tuesday.

Philadelphia Fed President Charles Plosser said keeping monetary policy too loose for too long could worsen the inflation problem by allowing expectations for ever higher prices to get built into consumer and business psychology.

"To keep inflation expectations anchored means that monetary policy-makers will have to back up their words with actions," Plosser told a gathering of regional businesses.

"We will need to reverse course," said Plosser, who dissented against two decisions of the central bank's policy-setting committee this year, always in favor of less easing. "I anticipate the reversal will need to be started sooner rather than later."

Plosser's remarks prompted the dollar to gain against the euro and yen, while yields on two-year Treasury notes rose.

His remarks "add to the increasingly strident anti-inflation rhetoric coming from the regional Federal Reserve bank presidents," said Michael Feroli, economist at JPMorgan.

Many market participants see an emerging rift between these folks and the Fed's board members, who appear more concerned about the risks to growth.

Lehman Brothers said in a report that it sees the probability of three voting members dissenting at the Fed's August rate-setting meeting in the wake of perceived hawkish comments from Plosser and from Minneapolis Fed President Gary Stern on Friday.