INCREASINGLY EXPENSIVE OIL is making the job of the United States Federal Reserve a lot trickier. As crude oil futures hit US$45 a barrel, can interest rates be raised to keep inflation in check without choking off the US economy? By raising the cost of borrowing for the second time this summer, Fed chairman Alan Greenspan appeared unmoved by the recent adverse impact of high oil prices on a slowing economy. No indication was given that a series of 'measured' rate rises will be a foregone conclusion later in the year. Overall the Fed remained upbeat after Tuesday's Federal Open Market Committee briefing, noting the US economy 'will see a stronger pace of expansion going forward', allowing for the measured increases. Mr Greenspan was singing from the same hymn sheet as HSBC chairman Sir John Bond, who at last week's results briefing said a gradual rise in interest rates could be good news as it reflected an improving economy. Given HSBC's weighty exposure to the riskier end of the US consumer-lending market through Household International, Mr Greenspan's remarks will be welcome. The potential monkey wrench in this benign scenario, however, is the insidious ascent of oil prices. For one, it makes higher interest payments for debt-laden American consumers more burdensome. Just how vulnerable motoring and free-spending consumers are remains hotly debated, but there is no doubt that they have been a key pillar of the US economy. One reading of the collapse in new job creation to just 32,000 last month, against expectations of more than 200,000, following a quarter point rate rise in June, is that monetary tightening has added potency when mixed with high oil prices and high debt levels. It remains to be seen if the July figures were a one-off, but with stimulus from tax cuts on the wane, upcoming economic data will be intensely scrutinised. The other challenge is that inflation is a larger threat than recognised and subsequent interest rate rises will need to be bigger still. Compared with Britain which has raised interest rates by 125 basis points since November last year, or Australia, the Fed has been slow off the blocks. By maintaining interest rates at 40-year lows, its policy is contributing to light-crude futures hitting 21-year highs. Annualised inflation of 3.3 per cent still translates to real interest rates deep in negative territory, despite the 50 basis points increase to date. As for how long we will have higher energy prices, Mr Greenspan appears to have his fingers crossed in hope it is a temporary phenomenon. Yet listen to oil industry experts and the debate is not when prices will retreat, but how soon they will test US$50. There appears little respite from a supply perspective. Opec insists it is already pumping at 95 per cent capacity. And it seems blaming China for driving crude oil prices up is questionable. Drastic tightening measures on the mainland have seen price drops in a range of commodities from copper to soyabeans, but the ascent of crude oil is unrelenting. In fact, if Mr Greenspan spoke to some electrical-product manufacturers in the Pearl River Delta, they would testify to the very permanent nature of price increases. Prices of plastic resins such as polypropylene derived from oil have risen by up to 50 per cent this year according to industry sources. Power and labour shortages have also added to the cost pressures. American consumers will find that DVD players or televisions made in China this Christmas will be more expensive due to oil prices. If interest rates are raised to curb oil-driven inflation, the painful fallout is that growth could also be curbed. Economists have resurrected the spectre of 'stagflation' - stagnating growth twinned with inflation. Interest rates might need to be left alone in such an environment. It still seems that high oil prices and higher interest rates make for an unpalatable mixture. Maybe the best bet is to join the Fed chairman and hope it is just a passing phase.