To Scott Anderson, senior economist at Wells Fargo & Co., the Federal Reserve has just taken away the punch bowl from a crowd of thirsty partygoers. The punch, of course, is cheap money that businesses have been feasting on to chase higher returns in emerging markets such as China and India. But inflation is breaking up the party, posing a challenge to U.S. economic growth. Higher energy and housing prices already are taking their toll. He expects U.S. economic growth will pull back to a 2.7 percent clip in the second quarter, down from 5.3 percent in the first quarter.

Question: Suddenly everyone is talking about inflation. What's going on?

Answer: We're telling clients to fasten their seat belts; 2006 is going to be a transition year. We're going to see delinquency rates and foreclosures increase for the next few years. Much of the concern centers on the consumer price index. The numbers this month were pretty clear - they showed a terrible inflation number. (The CPI has risen at a 5.2 percent annual rate so far this year, up from 3.4 percent last year.) That's going to weigh on market performance. The economic numbers just are not very comforting. It looks like the Federal Reserve will raise interest rates in June and they're likely to raise them again in August, though there's a lot of data between then and now.

Q: Consumers have already felt the pinch from energy prices, so what is the Fed focused on?

A: The Fed has gotten more vocal about inflation in the last couple of weeks in anticipation of more data coming out. Just a month ago, (Federal Reserve Chairman) Ben Bernanke was talking about containing core inflation. Now that's gone out the window. A lot of factors are playing into the Fed's concern. One is the fact that "capacity utilization" - that's the amount of capacity that is actually being put to work in the manufacturing sector - has gone above 85 percent, which is bad. That's when bottlenecks occur in manufacturing that drive prices higher. It's viewed as a gauge of wage and price pressures. And there are other signs in commodities of prices hitting record highs.

Q: What about housing?

A: We're seeing upward pressure on rents right now, which make up 40 percent of the core CPI index. The weakening housing market is adding to some pressure on rents. But there's debate as to whether it's a true inflation signal. The fact that energy prices have been so high for so long has taken many on the Federal Reserve Board by surprise. Businesses were temporarily able to hold off on price increases and hold off raising prices. But now they're passing through higher prices in order to maintain profitability. That's why we're seeing airlines raising prices.


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