Kansas City Fed President Thomas Hoenig (non-voter) says that inflation is becoming embedded in the economy and that may compel a significant interest rate hike. In a speech in Denver, Colorado, Hoeing that consumers are showing an "inflation psychology to an extent that I have not since the 1970s and early 1980s."

Hoenig suggested that the Federal Bank may have no choice but to raise rates as the economy begins to show signs of being at the brink of a recession. "A sharp slowdown in growth has put the economy at the brink of a recession while, at the same time, rising commodity prices have caused inflation pressures to rise considerably," Hoenig said.

Hoenig warned that a continuing policy of rate cuts will likely "weaken market discipline" and extend "moral hazard problems". Hoeing said, "As the economy recovers and credit conditions improve, however, it will be necessary for the Federal Reserve to remove the policy accommodation in a timely manner."

As the last rate cut and fiscal stimulus cheques make their way into the economy, Hoenig stated that the economy should begin to see signs of recovery in the second half of 2008. He did predict that Q2 U.S. growth should come in under 1%.

Hoenig is the Kansas City Fed's longest-serving member.

By Steve Stecyk and edited by Nancy Girgis