Fed officials keep door open to peak policy rate above 5.1%

Federal Reserve officials said on Tuesday the U.S. central bank will need to keep gradually raising interest rates to beat inflation and suggested sticky price pressures driven by a hot jobs market may push borrowing costs higher than they once thought.

“With the strength in the labor market, clearly there are risks that inflation stays higher for longer than expected, or that we might need to raise rates higher” than current forecasts hold, New York Fed President John Williams told reporters in New York.

The Fed’s policy rate is currently in a 4.50 percent-4.75 percent target range, and most central bankers as of December had indicated that 5.1 percent would be “sufficiently restrictive” to bring down inflation.

Williams on Tuesday sounded a touch more hawkish note, and said that ending 2023 with the benchmark overnight interest rate between 5 percent and 5.5 percent “seems to be the right kind of framing” for the policy outlook.

Speaking at Prairie View A&M University near Houston, Texas, Dallas Fed President Lorie Logan said that with an “incredibly strong” labor market pushing up wages and keeping inflation elevated, the Fed should not lock in a stopping point for rates just yet.

“We must remain prepared to continue rate increases for a longer period than previously anticipated, if such a path is necessary to respond to changes in the economic outlook or to offset any undesired easing in conditions.”

Williams and Logan spoke after a key U.S. government report on Tuesday showed consumer prices on a monthly basis accelerated in January, though the annual increase continued to gradually abate.

“It’s about as expected,” Richmond Fed President Thomas Barkin told Bloomberg TV when asked about the latest CPI data, cautioning that it will take a while for inflation to get back down to near the Fed’s 2 percent goal. By the Fed’s preferred measure, inflation is still running at a 5- percent annual rate.

“Inflation is normalizing but it’s coming down slowly,” Barkin said. “I just think there’s gonna be a lot more inertia, a lot more persistence to inflation than maybe we’d all want.”

Philadelphia Fed President Patrick Harker on Tuesday said the inflation news did not change his view that the policy rate will have to rise above 5 percent, though how much above that level “is going to depend a lot on what we are seeing … today, we had an inflation report that was good in that it is moving down, but not quickly.”

Still, Harker said, the Fed was “likely close” to reaching a sufficiently high enough level to pause.

As for what would come after, Williams flagged the prospect of rate cuts in 2024 should inflation continue to ease.

Brainard appointment

The Fed last year lifted interest rates further and faster than any time since the 1980s to fight inflation.

Following the CPI release on Tuesday, traders of interest rate futures now see the Fed raising borrowing costs three more times, bringing the policy rate to the 5.25 percent-5.5 percent range by July, if not June.

That’s up from only about even odds early on Tuesday for the rate to get that high.

The market repricing occurred before U.S. President Joe Biden announced his appointment of Fed Vice Chair Lael Brainard to head the White House’s National Economic Council. Brainard has supported the Fed’s rate rises to date, but has also been among those cautioning against overdoing them.

For her part, Logan noted the risk of going too far with the policy tightening, though she said the bigger risk was in doing too little.

“Even after we have enough evidence that we don’t need to raise rates at some future meeting, we’ll need to remain flexible and tighten further if changes in the economic outlook or financial conditions call for it.”

Key to that, Logan said, will be substantial further slowing in wage growth and better “balance” in what is now an “incredibly strong” labor market. The unemployment rate fell in January to 3.4 percent, the lowest since 1969.

While there has been progress on inflation, with a moderation particularly in goods prices and more recently in housing, Logan said, more is needed, especially for prices of core services excluding housing. Without improvement there, she said, inflation could land at 3 percent, above the Fed’s target.

“The most important risk I see is that if we tighten too little, the economy will remain overheated and we will fail to keep inflation in check,” Logan said.

Asked if it was still the case that the U.S. central bank risked doing too little rather than too much, Barkin also leaned towards the need to quash inflation as the priority, even as the Fed will use incoming data as its guide.

“It feels to me like the risk is on the inflation side at this point rather than the economy side,” Barkin said. “If inflation settles, maybe we don’t go quite as far, but if inflation persists at levels far above our target then maybe we’ll have to do more.”