Fed's Lockhart Drops Hint of Rate Hike

The Federal Reserve must "react decisively" to stop inflation from pushing up wages, one of its top policy-makers said Tuesday, dropping a clear hint about the possibility of interest-rate hikes ahead.


"Let me emphasize that I'm taking the recent inflationary pressures very seriously," Federal Reserve Bank of Atlanta President Dennis Lockhart told a panel discussion on the U.S. economy at Georgetown University.

"For that reason, in my view, the current set of circumstances calls for being especially vigilant and attentive to public and business psychology as regards costs and prices."

Lockhart is not a voting member of the Federal Open Market Committee, the Fed's interest-rate-setting committee, this year, but he will vote on policy in 2009.

"Policy needs to react decisively against signs of the onset of formal compensating practices, including contracts, that treat inflation as a persistent reality -- in other words, something that must be lived with. Such signs are not apparent, and I don't expect them to materialize," he said.

"There is no evidence of a wage-price spiral," he said.

The Fed halted an aggressive rate-cut campaign last week when it announced on June 25 that it held its benchmark fed fund rate target at 2 percent and warned that inflation had grown as a threat, while the downside risks to U.S. growth had receded.

No Need for Haste

Lockhart's remarks will likely reinforce the sense among investors that the next move in rates will be up as the Fed acts to keep inflation at bay.

However, he leavened his warning on price pressures with comments about the still fragile state of financial markets, and the gradual nature of the economic recovery, that did not
signal an imminent desire on his part for policy action.

Lockhart noted that first-half growth this year appeared to be coming in better than forecast and he said that it would probably achieve a pace of between 1 percent and 2 percent.

However, he noted that the second half of 2008 would probably not show much pickup from that level, while 2009 would continue this gradual recovery.

This was somewhat more upbeat than some economists who fear that U.S. growth will stumble once the $100 billion-plus being pumped into the economy via a government fiscal stimulus
has arrived and either has been saved or spent. The bulk of the rebate checks will have landed by mid-July.

Lockhart also said housing, whose problems triggered the collapse of the U.S. subprime mortgage market that unleashed a global credit crunch last August, might finally be healing.

"There are early and tentative signs that a bottom may be forming in some housing markets," he said.

U.S. exports were also aiding growth, in part due to the weaker dollar, Lockhart said.

However, he warned that the economy could still face a choppy ride and stressed that there was a lot of uncertainty.

In particular, financial markets outside of credit markets for investment-grade corporations were still stressed and banking was feeling the pain.

"Interbank credit markets continue to be stressed, reflecting concern over exposure to still volatile and declining asset values.

"The banking system now exhibits some signs of stress at all levels -- large financial institutions, regional banks, and community banks," he said.

Lockhart did not talk much about the economy during an audience question-and-answer session after his remarks, although he did touch on inflation targeting and said it was
under continual discussion at the Fed.

He also warned that Social Security and Medicare/Medicaid entitlement spending would create an "avalanche" of debt as more members of the baby boom generation retired in the years ahead.