Fed's Rosengren Calls for Gradual Hikes; Overheating Risks

--Inflation Shortfall Transitory But Employment Overshoot Persistent

--Worth Raising Interest Rates as Insurance Against Sharp Rise in Infl 

By Jean Yung

     WASHINGTON (MNI) - Boston Federal Reserve Bank President Eric Rosengren on

Wednesday called for "regular, gradual" interest rate increases to mitigate the

risk of overheating the economy and setting off an asset bubble or a sharp

acceleration in prices -- even in the face of weaker-than-expected inflation. 

     Current trends "suggest to me an economy that risks pushing past what is

sustainable, raising the probability of higher asset prices, or inflation well

above the Federal Reserve's 2 percent target," Rosengren said in remarks

prepared for the Money Marketeers in New York, N.Y.  

     "Steps lowering the probability of such an outcome seem advisable -- in

other words, seem like insurance worth taking out at this time. As a result, it

is my view that regular and gradual removal of monetary accommodation seems

appropriate." 

     A string of weaker inflation readings since the spring "appears to be

transitory," but the fact that the unemployment rate will be "materially below"

its estimated longer run sustainable level over the medium term will likely

boost wages and prices over time, Rosengren said. 

     The current unemployment rate of 4.4% is already below Rosengren's guess of

its sustainable level of 4.7%, he said, and some Federal Open Market Committee

officials expect it to dip below 4% by the end of next year. 

     "The likelihood of this outcome poses risks -- specifically that an

overheated economy will lead to price or asset-price inflation, risking the

sustainability of the recovery," he warned. 

     The last time unemployment rates trended toward 4%, in the late 1990s,

Rosengren noted, inflation and asset prices rose followed shortly by an economic

downturn and bursting of asset bubbles. 

     "Thus, in my view, appropriate risk mitigation would argue for continued

gradual removal of monetary accommodation, even though we are currently below

the inflation target," he said. 

     The Boston Fed chief, who doesn't have a vote on interest rates until 2019,

judged that the midyear decline in inflation is due in part to "some

idiosyncratic individual price decreases" and noted they will not fall out of

annual averages until next spring.

     Some Fed officials believe inflation will remain below the 2% target at the

end of 2018, but Rosengren noted that even the lower bound of the central

tendency range of FOMC forecasts, at 1.8%, is "relatively close" to the Fed's

objective.

     "I believe policymakers should not overreact to low current inflation

readings that are widely expected to be temporary," he said. 

     In the meantime, the broad economic impact of recent hurricanes will likely

cause temporary increases in inflation over the next several months before

"imposing another downward imprint on inflation" as gas prices return to normal.

     That noise will make it more difficult for policymakers to be fully

data-dependent in the near term, he said. 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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