Rumblings from the Federal Reserve suggest that inflation is now seen as the biggest threat to the US economy after Hurricane Katrina, despite concerns voiced by some about a potential slowdown.
The comments from several Fed members seem to send a clear signal that more interest-rate hikes are on the way, dashing hopes that the central bank would pause in the cycle of rate hikes.
"Inflation has been on an upward tilt the past couple of years. Now, the inflation rate is near the upper end of the Fed's tolerance zone, and shows little inclination to go in the other direction," Dallas Fed president Richard Fisher said in a speech on Tuesday to the Dallas Chamber of Commerce.
In these circumstances, market interest rates will naturally rise, and the Fed shouldn't get in the way, Fisher said.
"If the Federal Reserve were to resist the upward pressure on interest rates, it would in effect monetize the burgeoning fiscal deficits," Fisher said.
In a separate speech, William Poole, the president of the St. Louis Fed, said he had no doubt that the Fed would respond to any upward inflation surprise.
"I have no doubt that both the FOMC and the market would respond to surprises in core inflation that seemed likely to be persistent and to indicate a developing inflation problem," Poole said.
Although some Fed watchers have been hoping for the long period of easy monetary policy to last a bit longer, other experts say the Fed's tough stand is in fact a sign of confidence in the economy.
The federal funds rate stands at 3.75 percent after 11 quarter-point rate hikes, but economists note that is still low by historical standards.
The Fed's preferred measure of core inflation, which excludes food and energy costs, is running at 2.0 percent. But some see signs of hotter inflation, including a price index by the Institute of Supply Management on Wednesday.
The institute said a survey of industry executives showed that its non-manufacturing business activity index was at 53.3 percent last month, down from August's reading of 65 percent. The group's index of prices paid rose 14.3 points to 81.4 percent, the highest level and the biggest jump for the index in the eight-year history of the report.
The survey, whose results chipped away at broader Wall Street stock indexes on Wednesday, found that many business executives are concerned about the continuing rise in oil and gas prices after Hurricane Katrina and the toll rising energy costs will take on the economy.
Sal Guatieri at BMO Financial Group said the message from the central bank is not a more aggressive policy than up to now, but a continued pace of slow, but steady rate hikes.
"The Fed is indicating that the risk lies toward a faster rate of tightening as opposed to a pause," he said.
"But generally the comments suggest that the Fed will continue to raise rates at a measured pace and that's because the economy's underlying momentum is sustainable and the risk lies more toward higher inflation than weaker growth," he said.
Guatieri said he sees one more quarter-point hike next month and then a pause from the Fed, predicting additional hikes in 2006 that would put the funds rate at 4.5 percent by this time next year.
Citigroup's Robert DiClemente said rate expectations now have to be ratcheted upward.
"We are revising our forecast for short rates from a peak of 4.0 percent at year end to 4.5 percent early next year," he said.