The U.S. Federal Reserve Board will be patient in raising interest rates despite signs that inflation is heating up, according to Clément Gignac, strategist and chief economist at National Bank Financial.

In a new report, Gignac says the probability of a Fed rates hike before the U.S. presidential election is only about 25%.

“Stronger-than-expected increases in the U.S. CPI Wednesday morning and in retail sales Tuesday, combined with surging job creation two weeks ago, have brought concerns about interest rates and the direction of Fed policy back to Wall Street. With Fed funds futures now suggesting a rate hike as soon as August, do we still think the Fed will remain patient in removing its policy accommodation? Our answer is Yes,” he says.

Gignac argues that it will take more than one hot inflation reading to convince the Fed that it’s time to raise rates, particularly with manufacturing capacity utilization still below 80% and a persistent output gap. Also, the job market has a long way to go to recover the 2 million jobs that have been lost since 2001. “The Fed will not fall behind the curve if it keeps monetary policy accommodative all through 2004,” he says.

Also, Gignac warns that there’s a risk of provoking a hard landing by reversing the current monetary stance too soon. He notes that the current strength could be largely due to “non-recurrent fiscal stimulus (such as temporary income tax cuts for individuals and faster depreciation of capital goods acquired before January 2005)”. He adds, “The balance of risk still suggests the Fed will take its time.”

“As long as inflation does not accelerate enough to prompt restrictive action from the Fed, a return of some pricing power in some sectors, resulting from the decline of the U.S. dollar, should not be seen as bad news,” he argues.

NBF’s outlook of double-digit earnings growth in 2004 remains intact on the U.S. side. “Our year end S&P 500 target is unchanged at 1,225, based on earnings of $63 per share in 2004 ($68 in 2005). In Canada, our year end TSX target remains 9,200, based on $480 per share in 2004 ($540 in 2005). The recent BOC rate cut should limit the rise of the loonie and provide decent earnings numbers given the current rise of commodity prices.” NBF continues to recommend overweighting equities.

In sector strategy, NBF continues to overweight resources, particularly base metals and golds. “On base metal prices, as long U.S. consumer spending does not collapse and Chinese GDP continues to grow at more than 8% without too much domestic inflation, we see further upward pressure and remain comfortable with our overweight recommendation on the sector.”

“Given the record U.S. twin deficit (fiscal and current-account) -– about 10% of GDP – and the probability that the U.S. military will be in Iraq for some time, we see no rush to remove our recommendation to overweight gold stocks.”