By Michael S. Derby and Ann Saphir
May 29 (Reuters) – Federal Reserve officials continued on Friday to indicate that the US central bank may need to raise interest rates in the future if the war in the Middle East leads to further increases in already high inflation.
The possible change in monetary policy has been welcomed by Fed Vice Chair for Supervision Michelle Bowman, one of the central bank’s policymakers. Bowman told a conference in Iceland on Friday that the war and its energy shock could change his view of the price perspective.
“It still seems too early to assess the size and persistence of the economic effects from the Iran conflict,” he said, adding however that “if the disruption continues into the second half of the year, we could begin to see broader effects on inflation.”
If that happens, Bowman noted there’s a good chance he’ll “think about changing my way of thinking about the balance of risks,” a nod to the potential for rate hikes.
A number of Bowman’s colleagues worry that it may be difficult to dismiss the current energy shock as temporary, especially since inflation has been above the Fed’s 2% target for years.
That view has led to the willingness of these officials to consider raising prices to bring price pressure back in line.
“I think it’s premature for me to conclude that we need to raise rates right away, but it makes me continue to pay attention to the risk that inflation could continue to rise and inflation expectations could end,” said Minneapolis Fed President Neel Kashkari, one of the three hawkish opponents of the Fed’s policy decision last month.
Financial markets are betting the Fed’s next move will be to raise its benchmark interest rate from the current range of 3.50%-3.75%, likely by the end of the year. Before the start of the US-backed war with Iran, which led to massive supply distortions and energy price hikes, Fed officials were looking forward to a rate cut.
Speaking to a business group in New Jersey, Philadelphia Fed President Anna Paulson said Friday that monetary policy is “well-positioned” given unacceptably high inflationary pressures and economic uncertainty.
Paulson added that the Fed is ready to “react,” and while he sees US monetary policy in the right place, “I think it’s healthy for market participants to take situations where the (federal) rate remains unchanged for a long time, and situations where tightening is needed.”
But as San Francisco Fed President Mary Daly put it in an interview with Maria Bartiromo on Fox Business Network, “there is no immediate need to make adjustments” to interest rates.
“Policy is in a good place,” he added – a phrase Fed policymakers often use to indicate they are comfortable keeping the policy level where it is – and said any future moves could depend on when the war on Iran ends.
Oil futures fell more than 2% on Friday and were on track for their biggest weekly decline since early April after reports that the US and Iran had reached an agreement to extend their freeze for another 60 days.
TROUBLING INFLATION DATA
If oil prices “start to come down because the conflict is still going on, that would change my mind about the economy’s view on inflation,” Daly said.
He will also look to see if service industries start to raise prices, a worrying sign that inflation may continue. So far you get less of that outside of industries where fuel costs are a big part of the overall business.
Still, inflation risks are clearly increasing for the Fed, at least in the near term.
The New York Fed’s gauge designed to contain the strength of underlying inflation fell to 4% in April from 3.5% in March, according to data released on Friday. Prices of goods and services other than housing accelerated in April compared to the previous month.
Additionally, data released by the US government on Thursday showed the Personal Consumption Expenditures Price Index rose to 3.8% year-on-year in April from 3.5% in March.
Kansas City Fed President Jeffrey Schmid, speaking at the same conference as Bowman, said “his main concern is inflation, which is very hot and has been above target for a long time.” He added that the textbook strategy of looking at energy shocks as something that will not have lasting effects is currently ineffective.
Schmid also nodded toward the prospect of using the Fed’s balance sheet to help pump the brakes on price pressures.
“We haven’t cut back much yet and I think there’s a dialogue that … we need to start considering what tools we have to make it a little more restrictive,” depending on how the oil shock plays out.
“Maybe we look at the balance and as another tool … to create some boundaries,” said Schmid.
His view on the balance sheet may conflict with that of the Chairman of the Fed, Kevin Warsh, who has expressed doubts about using central bank bonds to increase interest rate policy.
(Reporting by Michael S. Derby and Ann Saphir in San Francisco and Jihoon Lee in Seoul; Editing by Paul Simao, Nick Zieminski and Daniel Wallis)
