MNI Exclusive: Fed Could Pause Rate Hikes as Early as Spring

--No Need For Restrictive Rates, Sources Say

--Officials See Neutral Around 3%

--Inflation Seen Easing

By Pedro Nicolaci da Costa and Jean Yung

     WASHINGTON(MNI) - The Federal Reserve could end its cycle of interest rate

hikes as early as the spring, as it starts to consider at least a pause to its

gradual monetary tightening since December 2015, senior Fed sources have told

MNI.

     That timeline would stand in sharp contrast with the Fed's own published

forecasts for rates, which foresee possible further increases in borrowing costs

well into 2020.

     Several factors are contributing to an increasingly urgent debate within

the Fed about how soon to stop tightening financial conditions, MNI's Fed

sources said. First, with inflation seen peaking around the Fed's 2% target

before drifting lower -- potentially more quickly than expected given the sharp

recent slide in oil prices -- policymakers see little need to make monetary

policy restrictive.

     That means policymakers are trying to get official rates, currently in a 2%

to 2.25% range, up to a level they consider "neutral" - neither boosting nor

slowing growth - but not beyond that. There is no firm consensus on the neutral

rate of interest, which changes with shifting economic conditions. But Fed

officials appear to be converging around 3%.

     So while a December rate hike is all but assured, the debate will become

more lively beginning at the central bank's March meeting and certainly by June.

     --RESETTING COMMUNICATIONS

     Financial markets were thrown into some disarray following very upbeat

remarks from Fed Chairman Jerome Powell in early October when he described a

"remarkably positive outlook" for the economy, among other superlatives

indicating optimism beyond that suggested by the Fed's median forecasts and

other policymakers' pronouncements.

     The effect on markets was so palpable and continuous that, in a clearly

coordinated step, Fed Vice Chair Richard Clarida struck a much more dovish note

in an interview with CNBC Nov. 16. He said "being at neutral would make sense,"

echoing what Fed staffers have told MNI about the central bank's thinking on

monetary policy deliberations.

     According to these sources, the Fed is just one or two hikes away from a

point where major decisions have to be made - in particular, whether the recent

growth spurt goes beyond a couple of quarters in a way that potentially

generates more inflation down the line or, as currently forecast, the stimulus

from heavy budget spending and tax cuts fades and gives way to more trend-like

2%-level growth.

     If the latter is true, then the rate hike cycle may be nearing a pause if

not an end altogether, despite worries by some policymakers that a 3%-or so

level of short-term interest rates will not be sufficient to allow the Fed to

ease properly during a future recession.

     Two days before Clarida's interview, Powell had also tempered his optimism

during a Q&A with Dallas Fed President Robert Kaplan, in which he highlighted

risks from weaker global growth, the fading effect of the tax cuts and the

lagged effect of the Fed's own rate increases.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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