July 22 (Bloomberg) -- Federal Reserve Bank of Philadelphia Charles Plosser said the central bank should raise interest rates ``sooner rather than later'' to lower inflation and prevent price expectations from getting out of control.

``We will need to reverse course -- the exact timing depends on how the economy evolves, but I anticipate the reversal will need to be started sooner rather than later,'' Plosser, who argued against cutting interest rates in two Fed decisions this year, said in a speech today in King of Prussia, Pennsylvania. ``It will likely need to begin before either the labor market or the financial markets have completely turned around.''

Plosser joins Minneapolis Fed President Gary Stern, who also votes on rate decisions this year, in making the case for raising borrowing costs, a move Fed Chairman Ben S. Bernanke avoided discussing in congressional testimony last week. Record oil prices and rising food costs this year have increased investor expectations for the Fed to raise the benchmark interest rate.

``Monetary policy cannot control changes in the relative price of a key commodity, like oil or food,'' Plosser said in prepared remarks to a breakfast hosted by the Philadelphia Business Journal. ``But it can help ensure that a relative price increase doesn't turn into a rise in overall inflation.''

Stern, the longest-serving Fed policy maker, said in a July 18 interview that ``we can't wait until we clearly observe the financial markets at normal, the economy growing robustly, and so on and so forth, before we reverse course.''

Market Expectations

Investors expect the Fed to raise the benchmark U.S. interest rate at least a quarter-point by year-end, based on futures prices. The Federal Open Market Committee next meets Aug. 5 in Washington.

Plosser dissented from the Federal Open Market Committee's March 18 decision to lower the main interest rate by 0.75 percentage point. He voted against the April 30 move to cut the rate by a quarter-point to 2 percent. At the last meeting, June 24-25, he supported the decision to leave the rate at 2 percent, a pause after seven straight reductions.

Plosser, 59, a former professor and business-school dean at the University of Rochester in New York, has taken one of the toughest anti-inflation stances on the Fed since joining the central bank in 2006.

His position today is ``not necessarily reflective'' of the broader group of Fed policy makers, said Richard DeKaser, chief economist at National City Corp. in Cleveland, in an interview with Bloomberg Television. At the same time, ``inflationary risks have risen,'' and ``they want to start laying the ground for eventual rate hikes to come,'' he said.

Uncertain Forecast

Plosser said recent turmoil at Fannie Mae and Freddie Mac, the largest U.S. mortgage finance companies, has ``shaken confidence in our financial institutions and markets,'' which has increased the ``uncertainty surrounding forecasts for the economy, including my own.'' The Fed announced on July 13 that it would lend to the government-chartered companies if necessary.

Washington-based Fannie Mae has fallen about 65 percent this year in New York trading, while McLean, Virginia-based Freddie Mac has tumbled about 74 percent amid concerns the companies lack enough capital to weather the worst housing slump since the Great Depression.

U.S. consumer prices surged 5 percent last month from a year earlier, the biggest increase since 1991, a government report showed last week. Such figures are fueling speculation the Fed will raise rates even as a yearlong credit contraction threatens to constrain economic growth.

Bernanke's View

Bernanke, in congressional testimony last week, said there are ``significant downside risks to the outlook for growth,'' and ``upside risks to the inflation outlook have intensified.''

American households foresee average annual inflation of 3.4 percent over the next five years, the highest expectation since 1995, according to the Reuters/University of Michigan survey.

``If we remain overly accommodative in the face of these large relative price shocks to energy and other commodities, we will ensure that they will translate into more broad-based inflation that -- once ingrained in expectations -- will be very difficult to undo,'' Plosser said today. ``I believe we must and will take the appropriate steps to ensure that does not happen.''

Bernanke said last week that markets and institutions ``remain under considerable stress.'' The benchmark Standard & Poor's 500 Index has dropped almost 20 percent from its record high in October. The subset of financial stocks has tumbled about 45 percent from May 2007.

`Sluggish' Growth

While the outlook for economic growth this year is ``somewhat better'' than a few months ago, Plosser said he expects ``sluggish'' growth in the second half and a rising unemployment rate.

At the same time, Plosser said he's ``generally more optimistic about 2009,'' projecting that growth in gross domestic product will rise to about 2.75 percent, with the jobless rate declining to 5.25 percent by the end of next year.

Inflation, both including and excluding food and energy costs, will drop to a range of 2 percent to 2.25 percent by the end of 2009, ``provided we set monetary policy appropriately to restrain inflation and keep inflation expectations well- anchored,'' he said.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net; Anthony Massucci in King of Prussia at amassucc@bloomberg.net.

Last Updated: July 22, 2008 09:13 EDT