What if slow U.S. economy doesn't cure inflation?

By Emily Kaiser and Brad Dorfman - Analysis

WASHINGTON/CHICAGO (Reuters) - Package delivery company FedEx Corp says demand is sluggish, yet fuel prices are rising so fast that its surcharges can't keep up.

The owner of the Arby's fast-food chain says its price increases are not enough to compensate for rising costs of beef, labor and utilities. Meanwhile, fewer customers are coming in the door as the economy slows.

It is the worst of both worlds for the U.S. Federal Reserve, which is supposed to balance inflation and growth but seems to be losing ground on each front. Much of the blame has gone to the sagging U.S. dollar, which makes imported goods, notably oil, more expensive. And global demand remains strong.

The central bank says the U.S. economic slowdown will help keep a lid on inflation by curbing demand for labor and materials. Chicago Federal Reserve Bank President Charles Evans said on Monday that inflationary pressures would likely diminish because "the ability of businesses to pass along price increases is not as high" in a weak economy.

So far, the signs are pointing the other way. A Morgan Stanley survey of equity analysts found that 63 percent of the companies they track had raised prices this year.

"Investors hoping for the ideal scenario of a mild global slowdown, a stronger (U.S.) dollar, cooling inflation and lower interest rates abroad seem likely to be disappointed," said Richard Berner, Morgan Stanley's chief economist.

"The baseline I see will involve an unappetizing combination of slower growth, high inflation, and little decline in interest rates," Morgan Stanley's Berner said.

Indeed, even as the U.S. economy shows unmistakable signs of slowing, consumer prices are rising for a host of items including air fares, cigarettes, food, and medical care.