Fed Reserve inflation fears grow

The US Federal Reserve is increasingly worried about rising inflation, minutes of its August meeting suggest.

On 9 August the US central bank voted to raise rates by one quarter of a percentage point from 3.25% to 3.5%.

Fed members warned that inflation was "at upper end of the range they viewed as consistent with price stability."

The Fed has raised the base rate ten times as it struggles to bring a torrid housing market under control amid signs high oil prices could boost inflation.

The US central bank also warned that economic growth was stronger than expected, and noted that "aggregate spending appeared to have picked up in recent months by more than anticipated."

Stronger growth

With the US economy continuing to grow strongly, the Fed said that "higher and rising energy prices were adding to pressure on overall inflation, and energy prices would probably feed through to core measures of inflation."

And it warned that "an increase in inflation from recent rates could have especially adverse effects on longer-run economic performance."

However, the central bank minutes suggest that, for now, the Fed will continue to adhere to its policy gradually raising interest rates, but that it reserves the right - if economic growth and inflation continue to accelerate - to put the brakes on more sharply.

House prices concern Fed

"The comments seemed reasonably hawkish. The Fed is concerned about inflationary pressures..It's certainly clear they are plan to continue to tighten," said David Sloan, a senior economist at 4Cast in New York.

Most economists believe that the Fed will continue to increase rates by 0.25% in its next three meetings until the end of year, leaving the Federal Funds rate at 4.25%.

Oil dilemma

However, other economists pointed out that the Fed's comments may be superseded by the effects of hurricane Katrina, which is increasing oil prices even further as Gulf refineries have been forced to shut down.

But opinion is divided about whether the effect of Katrina will be to raise inflation or to slow economic growth - the so-called "oil price shock" effect.

"People are focusing on the impact of higher energy prices on the consumer instead of focusing on the impact of higher energy prices on inflation", said Drew Matus of Lehman Brothers.

Others argue that Katrina will have only a limited effect on economic growth, other than raising insurance rates.

Housing slowdown?

The biggest dilemma facing Fed policy makers is how quickly the housing market will slow down - and what the economic effects would be.

The minutes note that "participants generally anticipated that the pace of home price appreciation would slow over time, though the timing and extent of that slowing, as well as its implications for consumer spending, were quite uncertain."

At the moment, rising house prices are helping boost consumer spending as people borrow against the increased value of their property.

But no one is sure, once house prices stop rising, how much this will affect consumer spending and consumer confidence.

So far, despite the increase in short-term interest rates from 1% to 3.5%, the long-term mortgage rates have barely changed, reflecting a glut of long-term debt on the market.