A DANGEROUS combination of mounting inflation and weakening growth now pose a double threat to US economic prospects, the International Monetary Fund said yesterday.

In a warning to the US over growing price pressures, Raghuram Rajan, the IMF’s chief economist, said that with inflation on the rise, even as the American economy slows, the Federal Reserve could soon face a quandary over its interest rate response.

"The Fed may soon be on the horns of a dilemma, and monetary policy will need to be skillfully managed if the economy is not to be gored," Mr Rajan said as he unveiled the IMF’s twice-yearly World Economic Outlook.

The Fed has been right to pause last month in its relentless, two-year long campaign of rate increases, Mr Rajan said. But he sounded a warning that, with increasing signs that inflation was still escalating, "pausing too long carries its own risks".

The IMF chief economist pointed to persistent pressures from past increases in the cost of commodities, a lack of slack in a US jobs market with strong employment levels, falling productivity, and a recent marked surge in wage pressures as worrying indication of inflation risks.

If these higher inflation began to fuel expectations of still further price increases among American companies and household, the Fed "will have to raise interest rates even higher and for longer", he cautioned.

But Mr Rajan emphasised the potential dilemma for the Fed and its chairman, Ben Bernanke, which also confronts a slowdown in US growth driven by the sharp downturn in the American housing market.

With US house price increases now having stalled completely, an expected housing slowdown was "well and truly here" and it was likely that "things will get worse before they get better", he said.

The IMF’s analysis highlighted the threat that the US housing market could cool more rapidly than anticipated, "triggering a more abrupt slowdown" of the US economy, as one of the key risks for the American and global outlook.

It also pointed to big uncertainties over how deep the impact of the continued US slowdown would be on other leading world economies.

Yet despite all of these concerns, the IMF’s central view of US and world economic prospects remains relatively upbeat.

Yesterday’s forecasts projected robust US growth of 3.1 per cent this year, slowing to a still respectable 2.7 per cent in 2007.

Explore Economics

• Autumn Budget 2007

• Budget 2008

• World Economic Forum

• The Times MPC

Times Recommends

• BA chief waives bonus after T5 fiasco
• Prospects of cheaper loans hit as Libor soars
• Rice price dives as US and Japan set to unlock grain pact