Fed Brainard: Should Be Cautious 'Til Confidence Infl on Track

--FFR Could Reach Neutral Without Too Many More Rate Increases

--'Prudent' for FOMC to Be More Gradual If Low Inflation Persists

--Bal Sheet Reduction Could Boost 10Y Yields 40bps Over Next Few Years

By Karen Mracek

     WASHINGTON (MNI) - Federal Reserve Governor Lael Brainard said Monday she

will look for more proof weak inflation is temporary and moving back towards the

the Fed's 2% target before supporting another increase in the fed funds rate.

     "My own view is that we should be cautious about tightening policy further

until we are confident inflation is on track to achieve our target," Brainard

said in remarks prepared for the Economic Club of New York.

     "Once balance sheet normalization is under way, I will be looking closely

at the evolution of inflation before making a determination about further

adjustments to the federal funds rate," she continued. "We have been falling

short of our inflation objective not just in the past year, but over a longer

period as well."

     Brainard, who as a governor votes each year on the policymaking Federal

Open Market Committee, did not rule out another rate hike this year saying the

FOMC will have "substantially more data in hand in the coming months that will

help us make that assessment."

     If inflation evolves as "many forecasters assume," if the current shortfall

from the 2% proves transitory, "further gradual increases in the federal funds

rate would be warranted, perhaps along the lines of the median projection from

the most recent SEP," she said.

     The June Summary of Economic Projections showed a median fed funds rate of

1.4% this year, implying one more rate hike before the end of the year, and

another three rate hikes in 2018.

     Brainard expressed concern "the recent low readings for inflation may be

driven by depressed underlying inflation, which would imply a more persistent

shortfall in inflation from our objective. In that case, it would be prudent to

raise the federal funds rate more gradually."

     While Brainard made clear inflation is the key to another rate hike, she

seemed comfortable with the FOMC moving ahead on its plan to end reinvestments

and begin reducing its balance sheet.

     "I consider normalization of the federal funds rate to be well under way,

the criterion for commencing balance sheet normalization," she said. "The

approaching change to our reinvestment policy has been clearly communicated and

is well anticipated."

     She also pointed to a recent study which showed a balance sheet runoff

"could boost the level of the term premium on the 10-year Treasury yield by

about 40 basis points over the first few years."

     Once the Fed puts its balance sheet reduction plan in place, Brainard

expects it to "run off in the background at the gradual pace that was

announced," she said, and for the FOMC to "primarily look to ongoing adjustments

in the federal funds rate to calibrate the stance of monetary policy."

     On rate hikes, inflation will be the key. Comparing the last three years,

when the unemployment rate averaged 5% with the three years before the crisis

when employment was similar, Brainard said the underlying trend inflation" may

currently be lower than it was before the crisis, contributing to the ongoing

shortfall of inflation from our objective."

     In order to combat that, she said "it is important to be clear that we

would be comfortable with inflation moving modestly above our target for a

time."

     Another key factor in the past three years' low inflation "is the decline

in import prices, reflecting the dollar's surge, especially in 2015," Brainard

said, but even as these prices have begun rising again in the past year,

"inflation remains relatively low."

     Along with low inflation, the neutral rate of policy remains low, and

therefore not too many rate hikes are needed to get to neutral. Brainard adds

her "current expectation is that the short-run neutral rate of interest may not

rise much over the medium term."

     To the extent that the neutral rate remains low relative to its historical

value, "there is a high premium on guiding inflation back up to target so as to

retain space to buffer adverse shocks with conventional policy," she said.

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

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