U.S. inflation could rise more quickly than forecast, and if this happens the Federal Reserve must raise interest rates faster and farther than currently thought, one of its top policy makers said on Thursday.
"There is a very substantial amount of uncertainty about where we are going to go, and it is going to be 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," Federal Reserve Bank of St. Louis President William Poole told Reuters in an interview.
"So it's important for the Fed to show leadership and to respond to the incoming information."
The FOMC meets next on June 29-30, and markets expect it to raise interest rates from a 1958 low of 1.0 percent.
The Fed has said it expects to be able to tighten monetary policy at a measured pace, although recent rises in consumer prices have raised fears that inflation may accelerate at a dangerous pace.
Poole, echoing Fed Chairman Alan Greenspan, vowed that this would not happen.
"If it looks like the signal is really there, then my personal position would be that it would be appropriate for the FOMC (Federal Open Market Committee) to move further and faster than priced-in in the market today," said Poole.
Greenspan said on Tuesday the Fed would "do what is required" to keep inflation in check if the forecast behind its view that interest rates can rise gradually turned out to be wrong.
A voting policy maker this year, Poole is seen as one of the more hawkish FOMC members for his views the Fed should aim for zero inflation "properly measured" -- taking into account the margin of error within the price data.
He was also quick to warn of the risk that inflation might be higher than forecast and as a respected economist, his views carry weight at the FOMC.
The core consumer price index, which excludes volatile food and energy prices, has risen at a three percent annual pace since the start of the year, a big pick-up from last year's 38-year low of 1.1 percent.
This has surprised some Fed policy makers but not Poole, who has been warning about this risk for a number of months and still sees it as a danger.
"I have said that the probability was higher we would have an upside (inflation) surprise than a downside surprise, and I agree that is probably a situation we face now," he said.
Not that he saw the case as clear-cut. Some gains could be blamed on higher oil prices, and it was hard to work out whether strong global growth would continue to underpin the energy market or if indications from oil futures that prices have peaked would prevail.
As a result, it was up to the Fed to separate the inflationary "signal" from the "noise" -- but if the signal produced evidence of a lasting price rise, action must follow.
"When you get compelling data you need to move, and if that move is in a way that is faster than the markets currently (indicate), then so be it.
"The market is not going to respond favorably and you're not going to help the situation if the market comes to believe that we are moving too slowly and we're letting the situation get out of control," he said.
The Fed has learned this lesson the hard way and spent 20 years squeezing inflationary expectations out of the U.S. economy. It has to protect this investment.
"I don't want to respond to noise. I don't want to respond to something that's temporary and I can't do anything about anyway. I do want to respond to signal, I do want to make sure that we do not allow the inflation problem to become embedded in the economy," he said.