Cleveland Fed's Mester: Further Rate Hikes 'Will Be Needed'

--Expects Infl to Reach 2% Target in Next Year or So Despite Recent Weakness

--Need to Continue Moving on Rate Hikes Because of Lag in Economic Impact

By Karen Mracek

     WASHINGTON (MNI) - Cleveland Federal Reserve Bank President Loretta Mester

said Wednesday the Federal Open Market Committee shouldn't wait too long to

raise interest rates higher even as she scrutinizes recent data to make sure the

weaker than expected inflation readings won't prevent the Fed from hitting its

2% target.

     "We can't wait until the goals are fully met because monetary policy

affects the economy with a lag," Mester said in remarks prepared for the

Community Bankers Association of Ohio's annual convention in Cincinnati.

     "We need to remain focused on the medium-run outlook," she said, adding "If

economic conditions evolve as anticipated, I believe further removal of

accommodation via gradual increases in the fed funds rate will be needed."

     Mester, a 2018 voter on the FOMC, did not say exactly when the next rate

hike should come, or when the FOMC should begin to wind down its $4.5 trillion

balance sheet. She repeated the committee could announce a change to its

reinvestment policy "relatively soon," which was the language used in the

post-meeting statement July 26.

     "The gradual, predictable decline allows balance-sheet normalization to run

in the background and monetary policy to focus on setting the appropriate level

of the funds rate, our conventional monetary policy tool," Mester said.

     Regarding the ultimate size of the balance sheet, she said, "the intention

is to reduce it over time to the smallest size needed to implement monetary

policy efficiently and effectively."

     But "because it will take several years to reduce the size of the balance

sheet through asset run-off, the FOMC can begin normalizing the balance sheet

before we have decided on the balance sheet's ultimate size," Mester said. 

     Even while sounding confident more rate hikes will be needed, Mester did

express some concern about recent weaker-than-expected inflation readings. 

     "Some of the weakness in recent inflation reports reflects special factors,

like the drop in the prices of prescription drugs and cell phone service plans,"

she said. "It may take a couple of months for these factors to work themselves

through, but these types of price declines aren't signaling a general downward

trend in consumer prices."

     Still, she'll "be scrutinizing incoming inflation data and reports from my

business contacts, but at this point, my assessment is that the conditions

remain in place for inflation to gradually return over the next year or so to

our symmetric goal of 2% on a sustained basis."

     These conditions include "growth that's expected to be at or slightly above

trend, continued strength in the labor market, and reasonably stable inflation

expectations," Mester said. Overall, though, "I believe the underlying

fundamentals supporting the economic expansion remain sound."

--MNI Washington Bureau;tel: +1 202 371-2121; email: karen.mracek@marketnews.com

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