WASHINGTON (Reuters) - The Federal Reserve will raise interest rates to prevent the world's top economy from overheating unless Asia's crisis dampens the frenzied pace of growth soon, Fed Governor Roger Ferguson said Tuesday.
In an interview with Reuters, Ferguson said domestic demand and the labor market had been so strong at the start of the year that a rise in inflation, rather than a slowdown in the rate of growth, now posed the main danger to the U.S. economy.
"Either Asia will slow the economy to something that is more sustainable or there will have to be some Fed action that will do that," Ferguson said.
"We are clearly above anybody's expectation of what a reasonable growth trend is. We may be in a position where we have above-trend growth which is unsustainable," he added.
His remarks jolted financial markets. Investors said they indicated mounting concern among Fed board members about the relentless pace of growth in the U.S. economy, which could prompt the central bank to raise credit costs before too long.
Prices in the inflation-sensitive bond market fell while yields, which move in the opposite direction of prices, rose. The dollar firmed against key currencies as higher interest rates would make the dollar a more attractive currency to hold.
"There is a group of people in the Fed that's worried, and if the economy doesn't slow down, it's going to be a problem to them," said James Glassman, senior economist at Chase Securities Inc. in New York.
The Fed has held interest rates steady for more than a year, and the key overnight federal funds rate stands at 5.5 percent. Its rate-setting council next meets on May 19.
Ferguson, who joined the Fed board last November after a 13-year career as a banking consultant, said policy-makers were eyeing data to be released over the second quarter of the year for "a clearer picture" of economic conditions. But he noted that at least so far, the impact of Asia's turmoil on the U.S. economy had been moderate.
Analysts on average expect the economy to have grown by 3.3 percent in the first three months of the year, after clocking a fiery 3.8 percent for all of 1997.
Characterizing such rates as "probably unsustainable by any reasonable measure," Ferguson warned: "The risk we face now is that Asia will slow us down less than we thought. The risks have moved from being balanced to perhaps being tilted toward the upside."
The Fed last December dropped a bias toward raising rates, adopting a neutral policy stance of keeping rates on hold. The move reflected a belief among most policy-makers at the time that the risks to the economy were balanced, requiring the Fed to keep all its options on the rate front open.
With consumer prices rising at a meager 1.4 percent from the same time a year ago, Ferguson said the U.S. economy may well be headed toward price stability. Stable prices and maximum employment together form the Fed's twin mandate.
But he warned it was crucial to "hold on to that victory," particularly since many factors helping to keep inflation low may not last forever.
"You don't have overheating showing up just yet because there are special factors holding down inflation," he said. He did not specify the factors, but policy-makers have previously cited the firm dollar and low commodity prices as contributing to low inflation and strong growth.