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Federal Reserve Bank of Kansas City President Thomas Hoenig said “serious'' inflation pressures may compel the central bank to increase interest rates. The dollar rose against the euro.

“There is a significant risk that higher inflation will become embedded in the economy and require significant monetary policy tightening to reduce it,'' Hoenig said yesterday in the prepared text of a speech in Denver. Consumers are gaining an “inflation psychology to an extent that I have not seen since the 1970s and early 1980s,'' he said.

Hoenig's warning supports speculation among investors that the central bank has finished its series of rate cuts after seven reductions since September. Policy makers last month lowered the benchmark by a quarter point and signaled they are ready for a pause, omitting a previous reference to “downside'' risks to economic growth.

“A sharp slowdown in growth has put the economy at the brink of a recession while, at the same time, rising commodity prices have caused inflation pressures to rise considerably,'' Hoenig said to the Economic Club of Colorado. He isn't a voting member of the Federal Open Market Committee this year.

Traders anticipate the Fed will leave its main interest rate unchanged at 2 percent through October, based on futures prices on the Chicago Board of Trade.

After Hoenig's comments the dollar climbed to $1.5482 against the euro as of 3:38 p.m. in Tokyo, from $1.5532 in New York late yesterday. The yield on the benchmark 10-year Treasury note rose 1 basis point to 3.93 percent.

Second-Half Recovery

Interest rates are low enough that, when combined with tax rebates passed by Congress, the economy should begin to pick up in the second half, Hoenig said.

“The current accommodative stance should be sufficient to cushion the economy from a deeper slowdown,'' he said. “As the economy recovers and credit conditions improve, however, it will be necessary for the Federal Reserve to remove the policy accommodation in a timely manner.''

Hoenig, 61, dissented from a rate cut on Oct. 31 because of his concern about inflation. Dallas Fed President Richard Fisher and Philadelphia's Charles Plosser voted against the past two rate cuts.

The current economic weakness can be largely attributed to slumping housing construction and higher energy prices, which reduced consumer and business spending, Hoenig said.

Market Disruptions

“Financial market disruptions, while noteworthy, are not the major story behind the recent weakness,'' he said. “Energy price increases and housing dominate this slowdown.''

The U.S. economy lost 20,000 jobs in April and gross domestic product expanded at a 0.6 percent annual pace in the first quarter, the same as the previous three months, giving the slowest six months of growth in seven years.

The economy is “sliding into a recession,'' Martin Feldstein, a member of the committee that charts the American business cycle, said yesterday.

“This is a weakening economy,'' Feldstein, president of the National Bureau of Economic Research, said in a Bloomberg Television interview in New York payday loans http://us-no-fax-payday-loans.com. “If you compare where the economy is now, with where it began at the beginning of the year, just about every indicator is down.''

Housing Slump

Federal Reserve Chairman Ben S. Bernanke, seeking to end the worst housing slump in a quarter century, urged the government and mortgage lenders in a speech May 5 to intensify efforts to avoid defaults. Foreclosure filings rose 57 percent in March from a year earlier, according to Irvine, California-based RealtyTrac Inc.

Still, “there are reasons that suggest the economic slowdown will be short-lived,'' Hoenig said, citing low interest rates, tax cuts and rising exports.

Hoenig joined the Fed district bank in 1973 and became its president in 1991. The Kansas City Fed chief is the longest- serving official among district-bank presidents and Fed governors after Gary Stern of Minneapolis.

In the question period, Hoenig said the U.S. dollar's decline in recent years has helped exports. The currency has fallen in part because of the U.S. current-account deficit, which will require the U.S. to save more over time, he said.

“Our economy is consuming more than it is producing,'' Hoenig said.

The current account deficit “is the issue that has to be addressed,'' he said. “That is the issue around the dollar.''

Inflation `Troublesome'

The combination of slowing growth and inflation is “troublesome,'' Hoenig said in his text. Rising global commodity prices and higher prices of imported goods from China and other markets are pushing up prices.

“Some would dismiss these rising inflationary pressures as temporary,'' he said. “I believe they are more serious.''

The Federal Reserve's preferred measure of inflation, which strips out food and fuel prices, increased 2.1 percent in March from 12 months earlier. Including the two items, prices climbed 3.2 percent, the fifth straight month in excess of 3 percent.

Public expectations of inflation five years in the future rose to 3.2 percent in April, the fastest since October 2005, as measured by a Reuters/University of Michigan survey.

Financial markets are showing signs of stabilizing, though a full recovery will take time, Hoenig said.

The Federal Reserve's rescue of Bear Stearns Cos. may encourage undue risk taking among investors, Hoenig said. The Fed provided $29 billion in financing to secure JPMorgan Chase & Co.'s takeover of Bear Stearns.

Supported Decision

Hoenig in the question period said he supported the decision to aid Bear Stearns.

The central bank's actions to stabilize markets “seem likely to weaken market discipline and extend moral hazard problems to a much wider financial marketplace,'' he said.

Fed policy makers in coming months may have to make decisions that defy public preferences, Hoenig said.

“There are many challenges ahead, many choices to make,'' he said. “Some I suspect will be desperately unpopular.''

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