KENOSHA, Dec 2: Federal Reserve policy-makers on Friday said inflation remained a risk to the US economy, even as data showing factory activity falling for the first time in 3-1/2 years indicated growth was slowing.

Chicago Federal Reserve Bank President Michael Moskow said risks were still somewhat tilted toward inflation rather than slowing growth, while Fed Vice-Chairman Donald Kohn said that while the inflation trend had shifted down, there were still upside risks.

"Some additional firming of policy may yet be necessary to bring inflation back to a range consistent with price stability in a reasonable period of time," Moskow told the Carthage Business and Professional Coalition. But investors bet on the weaker data, not the Fed.

US Treasury debt prices rose and benchmark yields slid to 10-month lows while share prices and the dollar fell on mounting concerns over the slowing economy and growing expectations for the Fed to ease monetary policy next year.

The Institute for Supply Management's index of national factory activity dropped to 49.5 in November from 51.2 in October. It was the first time the index had fallen below 50 since April 2003. A reading below 50 indicates contraction.

Moskow, who will be a voting member of the Federal Open Market Committee in 2007, said further policy firming would depend on upcoming US economic data.

The Fed has held benchmark interest rates steady at 5.25 per cent for its past three meetings.

In answering questions after a speech in Washington, Kohn said inflation trends were shifting "from up to down," adding that inflation "seems to be shifting toward a gradual decrease but the risks are tilted to the upside."

Separately, Richmond Fed Bank President Jeffrey Lacker said at an event in Philadelphia that market risks were not a factor in his vote against the Fed's recent decisions to hold rates steady. Lacker, the lone dissenter in the Fed's last three decisions, would have preferred the Fed to raise rates.

Data this week, which included durable goods orders and new home sales, have been soft, and the ISM report in particular reinforced expectations the next Fed move would be an easing.

"The mounting evidence that growth has slowed further in the fourth quarter is bolstering the case that the next Fed move will be a rate cut -- perhaps as early as the first quarter," Nigel Gault, chief US economist at Global Insight in Lexington, Massachusetts, said in a research note.

After the ISM report, Fed funds futures saw a roughly 70 per cent chance of a cut at the Fed's March policy-setting meeting, up from about 50 per cent at Thursday's close.

In an interview with Reuters, Paul McCulley, managing director at Pacific Investment Management Co, said: "ISM is the single best indicator of Fed cycles; a reading below 50 always begets an easing cycle."

"The only question is whether the Federal Reserve loses the bias on the 12th," he added, referring to the policy-setting Federal Open Market Committee, which meets next on Dec. 12.

Fed Chairman Ben Bernanke did not discuss the economy, the outlook for inflation or interest rates on Friday in remarks at a conference on monetary policy.

However, Bernanke on Tuesday said the risks to the inflation forecast "seem primarily to the upside."

"Given the current level of inflation, a failure of inflation to moderate as expected would be especially troublesome," he said.

Philadelphia Fed Bank President Charles Plosser on Friday suggested markets should not read too much into the ISM numbers, and he still felt inflation would need to come down further if the economy resumed near-trend growth as expected next year.—Reuters