MNI: Fed's Bullard Raises Peak Rate Projection To 5.6%

U.S. interest rates will need to rise to a 5.5%-5.75% range and stay there until next year to bring down inflation assuming turmoil from the collapse of several banks dissipates, Federal Reserve Bank of St. Louis President James Bullard said Friday.

His forecast is a quarter-point higher than in December "in reaction to the stronger economic news and under the assumption that the financial stress abates in the weeks and months ahead," he told reporters after giving a talk in St. Louis.

The Fed's swiftly launched emergency lending facility for banks "goes to the heart of the matter" and allows the Fed's interest rate policy to be carried out separately, Bullard said.

"I would put 80% probability on the case where financial stress abates. If it doesn't abate, that's a completely different world where financial stress gets more intense, and I would be willing to react to that. But you would have to get into that scenario before I would know exactly how to play that," he said.

UNUSUAL SITUATION

Silicon Valley Bank was a very unusual bank and the most likely outcome is the new Bank Term Funding Program will be successful in containing the turmoil, he said.

Small and midsize banks around the country have conveyed "angst" about the prospect of deposits leaving the banking system in search of higher short-term yields elsewhere, but "most banks are not anything close to that situation and they will manage their affairs going forward," Bullard said.

"I put as a base case that the economy will continue to grow and the end of year growth rate will be higher than the SEP," he said. The median FOMC official expects GDP growth to slow to 0.4% by year-end.

Any tightening in credit as a result of financial system stress should help the Fed in its fight against inflation, he added. "We have been raising rates and part of the strategy has been to slow the economy some so we have less inflationary pressure," he said.

"The disinflation process will come from the business side where the price setters begin to reconsider raising prices further and lose market share."