The Fed faces a difficult task in deciding when to stop raising rates, officials warned

The US central bank is entering a new phase of policy tightening that will be harder to navigate, a top official has warned, as pressure builds on the Federal Reserve to temper what has become one of its most aggressive campaigns to raise interest rates in decades.

“The next phase of policy making is more difficult, because you have to keep many things in mind,” Mary Daly, president of the San Francisco branch told the Financial Times.

“You have to remember the cumulative tightening that has been in the system. You have to be mindful of the monetary policy lags. You have to remember the risks that exist throughout the global economy and the incredible uncertainty that we have even about what the evolution of inflation will be.

Daly is among a growing cohort officials to support a slower rate of increase. This is partly because the tightening is already in train, but also because it takes several months for the full effect of policy adjustments to be felt and even more time to show up in economic data. Interest rate-sensitive sectors such as housing have felt the brunt of higher borrowing costs, but further price pressures continue to mount and the labor market is tight.

In less than a year, the Fed has raised the federal funds rate by 3.75 percentage points, depending on the swingeing 0.75 percentage points increase to make up the ground against inflation that has been consistently surprising in its intensity.

With the benchmark policy rate currently hovering at a level considered “moderately restrictive” on economic activity – between 3.75 per cent and 4 per cent – Daly said that challenge The Fed is now faced with determining what rate will be the “restrictive rate” to bring inflation back down to the central bank’s 2 percent target.

“If I could do one thing for society, I would say: stop thinking about speed and start thinking about level.”

Jay Powell, the chair, said this month that the Fed may moderate the rate of tightening at the next meeting in December, but stubbornly high inflation likely means that the level at which the rate of Fed funds will be out will be higher than previously expected. . Daly said the “terminal” level is “at least 5 [per cent] I think so”.

Federal Reserve Governor Chris Waller told the UBS conference in Australia on Monday morning that rates are going to “continue to rise” and “remain high for awhile until we see inflation is getting lower closer to our target”.

Asked if the rate could hit 5 percent, Waller replied: “It depends on what happens with inflation. If inflation doesn’t go down or bounce back, we might have to go higher. . . Now inflation determines where that number will end up.”

In his interview, Daly said that the Fed is also focused on how long to keep the policy rate at a sufficiently tight level.

“If I can hold it there [at an elevated level] for a year and really think that inflation is going down, then that’s probably a reasonable level to stop,” said the San Francisco leader. “Overnight to 2 percent is not my goal . . . but we cannot afford to let inflation continue to erode America’s real purchasing power.

Move too slowly to root out inflation as well as the risk of future inflation expectations being unmoored to a degree that necessitates the Fed to take more stringent action, warned Daly, who maintains that the Fed will be able to avoid job losses akin to a “severe recession”.

Citing sweeping layoffs in technology companies, which have included Meta, Stripe and Lyft, he argued that “rebalancing” there appears to be specific to the tech sector as opposed to a broader-based sign. “They’re very excited about the growth rate they’re seeing in the pandemic and they’re hiring as if that growth rate is going to last forever, and then that growth rate drops back down to more traditional levels.”

Beyond the economic pain, another concern is the financial distress that has forced the Fed to intervene despite plowing ahead with its efforts to tackle inflation – something the Bank of England was recently forced to do after the British government bond market. be seized. The lesson there, according to Daly, is that drawing a distinction between monetary and financial stability tools “can be done, but it makes for some challenging communication”.

Asked about turmoil that has gripped cryptocurrencies, Daly said the central bank is paying attention to where “cross-contaminations” may appear between companies and retail and institutional investors, but now they do not see a “big risk” to financial stability, and people continue to reduce. their exposure.

“Each time this happens, hopefully the impact on the general financial system and retail and wholesale investors is smaller.”

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