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Federal Reserve

policymakers noted at their Aug. 9 meeting that higher energy costs and "reduced resource slack" could spur price pressure, although for the most part inflation continued to be held in check by the central bank's "measured" approach to interest rate tightening.

"Notwithstanding recent benign readings on inflation, the forecast for core

consumer inflation was raised somewhat, owing in part to the recent further rise in energy prices and, in light of the revisions to historical data, a higher assumed trajectory for the nonmarket component of core

consumer prices."

Minutes from the Federal Open Market Committee meeting also discussed the market's reaction to a series of indicators over the summer that suggested the economy was picking up. Yields on Treasury bonds rose while stocks benefited from a series of strong earnings reports.

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"Over the intermeeting period ... investors appreciably marked up their expectations for the path of policy, primarily in response to incoming economic data suggesting more strength in spending and output than had been anticipated."

Indeed, the Fed's own staff prepared a report for the Aug. 9 meeting that upwardly revised the estimate for 2005 growth while tempering the view for 2006. The 2006 reduction reflected expectation for "higher energy prices, higher long-term interest rates, and the somewhat slower growth of productive capacity implied by the annual revisions to the national accounts."

Most of the FOMC's members believed at the time that more interest rate hikes would "tend to hold inflation pressures in check," although not everyone was convinced that the situation was ideal.

"While recent monthly readings indicated that core inflation had been subdued, a number of participants noted that underlying core inflation appeared to be running at a pace around the upper end of the range they viewed as consistent with price stability," the minutes read. "Participants commented that an increase in inflation from recent rates could have especially adverse effects on longer-run economic performance."

Regarding another source of economic heat, the real estate market, Fed members noted that with housing starts essentially flat, "residential investment was projected to decelerate substantially over the remainder of this year.

"Business investment was predicted to continue to rise at a moderate pace, benefiting from still-accommodative financial conditions and the ongoing need to replace depreciating equipment and software."