MNI: Fed's Mester Expects 'Somewhat Further' Tightening

Federal Reserve Bank of Cleveland President Loretta Mester on Thursday endorsed a May interest rate increase and said she's prepared to adjust her views on how much higher and for how much longer rates will need to rise based on changing economic and banking conditions.

Still-unfelt effects from previous interest rate hikes and a potentially large contraction in credit conditions as a result of bank failures last month argue for prudence in projecting the Fed's policy path this year, even as inflation remains too high, she said.

"In order to put inflation on a sustained downward trajectory to 2%, I anticipate that monetary policy will need to move somewhat further into restrictive territory this year, with the fed funds rate moving above 5% and the real fed funds rate staying in positive territory for some time," she said in remarks prepared for The Akron Roundtable Signature Series in Ohio.

"Precisely how much higher the federal funds rate will need to go from here and for how long policy will need to remain restrictive will depend on economic and financial developments."

CREDIT CONDITIONS

Rate hikes are working to slow the economy and bring down the pace of price gains, but inflation is "proving to be stubborn," Mester said. Inflation in core services categories outside of shelter has not improved, driving the stickiness of high inflation.

Tighter financial conditions should continue to bring demand back into balance with supply, pushing inflation down to 3.75% this year and the unemployment rate up to 4.5% to 4.75%, and growth below its recent trend, she said. Those estimates are on the higher end relative to her FOMC colleagues.

But there is "heightened uncertainty" around the economic outlook, with a possibility the recent banking panic resulting in tighter credit standards could serve to pull back household and business spending. (See: MNI INTERVIEW: Fed Close To Done As Credit Tightens-Kroszner)

"This would work in the same direction as tighter monetary policy. So we will need to continue to assess the magnitude and duration of these effects on credit conditions to help us calibrate the appropriate path of monetary policy going forward," she said. "I am prepared to change my views on the economy and appropriate monetary policy as changes in conditions warrant."