Fed warns on inflation as oil prices continue to rise

The vice-chairman of the Federal Reserve has warned that the US faces serious economic problems if the public comes to expect higher inflation in the future.

Donald Kohn said he continued to believe that high energy and food inflation would moderate later in the year, and expressed satisfaction that wage pressures have not been rising, but he sounded his warning note as crude oil prices surged to another record and producer price inflation data for April was stronger than expected.

"My expectations for moderating inflation and limited spillover effects from commodity price increases depend critically on the continued stability of inflation expectations," Mr Kohn said, in a speech to a pensions conference in New Orleans. "If longer-term inflation expectations were to become unmoored – wheth-er because of a protracted period of elevated headline inflation or because the public misinterpreted the recent substantial policy easing as suggesting that monetary policy makers had a greater tolerance for inflation than previously thought – then I believe that we would be facing a more serious situation."

Amid new predictions that demand for oil would continue to outstrip supply, oil prices passed $129 a barrel for the first time in New York trading yesterday. At its peak, light sweet crude was up $2.26 to $129.31. It closed at $129.07. In London, Brent crude rose $2.78 to $127.84.

Goldman Sachs predicted this month that oil could spike to $200, and a string of other banks have increased their forecasts in recent days. Yesterday, Boone Pickens, the veteran oil investor, predicted $150 oil within the next few months.

The latest upward leg to the oil price was helped by a decline in the dollar, which fell relative to a basket of other currencies on talk that other countries will keep interest rates high to combat inflation.

Inflation expectations have been creeping higher among US consumers, Mr Kohn warned, as the rising cost of food and petrol become hot-button political issues.

And there was little obvious respite from the inflationary pressures in yesterday's producer price figures, which measure wholesale inflation which may or may not eventually be passed on to the consumer. The headline figure for April showed annual inflation running at 6.5 per cent, down from 6.9 per cent because of seasonal adjustments to food and energy prices. But the core rate, which excludes these volatile elements, ticked up to 3 per cent. The month-on-month increase of core inflation was 0.4 per cent, double Wall Street's expectations.

The figures renewed concerns that the Federal Reserve will end up having to increase interest rates to tackle inflation, even if the US economy remains weak, fears that sent stock markets sharply lower on both sides of the Atlantic.

"Nothing here bodes well for consumers," said Joel Naroff, president at Naroff Economic Advisors.