TD Bank economists are predicting that the U.S. Federal Reserve will start hiking rates in June to stave off high inflation.

In a newly released special report TD economists warn “Even using modest assumptions about prices over the next 6 to 9 months, core inflation could edge above 3% by early 2003”.

They forecast that such a rise in inflation will move the Fed to begin increasing interest rates by June, in order to limit the rate of core inflation to 2.5%.

“At present, the headline and core CPI numbers present a relatively benign picture of inflation, so it is hard to see why inflation could pose a threat down the road. But, digging beneath the surface reveals why core CPI has remained so steady — the continued upward grind of the prices of services has been offset by falling goods prices,” TD notes. “However, goods prices are not going to fall forever, and when they start to reverse course later this year, they will no longer be providing an offset to the climbing prices of services.”

As the U.S. economy starts to emerge from recession, the discounting that drove many core goods prices lower will diminish, TD argues. “Indeed, if the pace of inflation on core goods rises to a still-low 1.3%, and core services inflation continues to run at around 4%, core inflation could easily hit 3.2% early in 2003 — the highest reading in nine years.”

Only preemptive actions by the Fed will prevent inflation expectations from rising, TD says. “The Fed is likely to raise the target Fed funds rate by 125 basis points by the end of 2002, with a further 175 basis points in store in 2003. This will go a long way to ensure that inflation remains subdued as the economic recovery progresses,” concludes TD.