Fed's Fisher: Fed must be ready to act on inflation

By Alister Bull

ASPEN, Colo. (Reuters) - The Federal Reserve must be ready to take action if slowing economic growth fails to curb inflation stemming from higher food and energy prices, one of its top policy-makers said on Tuesday.

"Until we have a clear sense of what will prevail, monetary policy makers must remain poised to act if slowing growth fails to contain inflationary pressures," Dallas Federal Reserve Bank President Richard Fisher said in prepared remarks. A text of his speech was made available to the media.

Fisher is a voting member of the Fed's interest-rate setting committee this year and has dissented at every meeting so far in favor either of higher rates, or of less aggressive easing. This has earned him a reputation as one of the most hawkish, or anti-inflation, officials at the U.S. central bank.

"Unless the python that is the U.S. economy can quickly pass the recent burst of cost-push pressures, we risk a reinforcing spreading of inflationary impulses and expectations," he told the Progress and Freedom Foundation.

"Should this happen and the Fed were to fail to address it, we would run the risk of losing the public's confidence in our ability to constrain inflation," he said.

Earlier on Tuesday, the Labor Department reported that U.S. wholesale prices rose sharply. Producer prices in July were up 9.8 percent from a year ago, the biggest increase since 1981, while prices excluding food and energy were up 3.5 percent, the biggest rise since 1991.

The Fed halted its aggressive rate cutting campaign in June after slashing its benchmark overnight fed funds rate 3.25 percentage points to 2 percent since mid-September to shield the economy from a housing crisis and credit crunch.

Fisher said the Fed had "done its job on the growth front", although he warned the economy would slow to a snail's pace in the second half, if not grind completely to a halt, before a recovery unfolds in 2009 to take it back to trend growth.

"If you were a yachtsman, you would say that we sailed the economy along in a following sea for a long time; now we are navigating force 10 seas. Everyone is battening down the hatches," he said.

He also acknowledged that current market conditions remained very fragile.

"The correction in the housing market has yet to find its bottom. Credit markets remain tempestuous," he said, subtly reinforcing market expectations that the Fed will keep rates on hold in the months ahead.

The Fed has telegraphed its desire to keep rates steady while waiting for credit market strain from massive subprime home loan losses to fade, then take back its policy accommodation to keep inflation at bay as and when it can.

Fisher said this forbearance was a delicate balancing act but should not be mistaken for a gamble with the central bank's hard-won credibility.

Fed policy-makers "have no intention of squandering the bedrock capital of a central bank: the confidence the public places in our hands to keep inflation at bay while we work to bolster economic growth and restore the financial system."

(Reporting by Alister Bull; Editing by Chizu Nomiyama)