Fed warning on interest rates has sterling reeling against the dollar

The pound plunged against the dollar yesterday after three senior members of the US Federal Reserve warned that the central bank was ready to raise interest rates faster than the markets were expecting.

The pound plunged against the dollar yesterday after three senior members of the US Federal Reserve warned that the central bank was ready to raise interest rates faster than the markets were expecting.

Federal Reserve Bank presidents Jack Guynn, William Poole and Sandra Pianalto joined the chairman, Alan Greenspan, in warning that the Fed was worried about inflationary pressures. Policy makers may need to raises their target rate "further and faster" than investors are betting if prices exceed Fed forecasts, Mr Poole said.

Mr Guynn, the Atlanta Fed president, said there had been a "flurry" of price rises across the economy. "Recent developments on the price front warrant significant attention in our analysis and policy debates," he said. The comments triggered a surge in the dollar as traders bet that the Fed would raise rates more aggressively than they had expected until this week.

Ms Pianalto, the Cleveland Fed President, said rates were too low to be sustainable. "Failure to respond in a timely fashion puts our hard-won credibility at risk," she said.

Sterling suffered its biggest fall in seven weeks, plunging two cents against the dollar to $1.8218. The dollar also rose strongly against the euro and the yen. "The Fed is trying to break the bad news gently to the markets," said Ethan Harris, the chief economist at Lehman Brothers in New York, which expects the Fed to order its first rate rise in four years on 30 June.

Since the start of this year the Fed had said it would only raise interest rates at a "measured pace", based on its forecasts for a gentle recovery On Tuesday, Mr Greenspan surprised the markets by warning that the Fed would "do what is required to fulfil our obligations" if the economy started to rebound. Yesterday, Mr Guynn and Mr Poole chose a day when the financial markets were shut for the funeral of the late US president Ronald Reagan to hammer home the message.

In an interview with Reuters Mr Poole, the president of the St Louis Fed, said: "It is going to be very important for the Federal Reserve to be prepared to respond to new information ... if we end up with inflation coming in on the high side of expectations.

"If it looks like a signal is really there, then my personal position would be that it would be appropriate for the [Fed] to move further and faster than is priced into the market today."

Addressing an audience of property brokers, Mr Guynn said: "In my personal view, the word 'measured' is more of a plan than a pledge. Not only is it important that we prevent appreciable price increases from taking hold, but it is vital that we maintain the Fed's credibility for following a policy path that keeps inflation in check over the long haul."

The Fed has held its main lending rate at a 46-year low of 1 per cent for a year.