MNI: Fed's Mester Sees Rates Staying Above 5% For Some Time

U.S. interest rates need to rise above 5% and stay there for some time, Federal Reserve Bank of Cleveland President Loretta Mester said Thursday, warning inflation risks are still tilted to the upside and the cost of prematurely loosening policy outweighs the cost of doing too much.

The stronger-than-expected January CPI report offers "a cautionary tale against concluding too soon that inflation is on a timely and sustained path back to 2%," she noted, while the Ukraine war and China's emergence from its zero-Covid policies mean food and commodities prices could move up again.

"The incoming data have not changed my view that we will need to bring the fed funds rate above 5% and hold it there for some time to be sufficiently restrictive to ensure that inflation is on a sustainable path back to 2%," she said in remarks prepared for a Global Interdependence Center event.

"Indeed, at our meeting two weeks ago, setting aside what financial market participants expected us to do, I saw a compelling economic case for a 50-basis-point increase, which would have brought the top of the target range to 5%."

UPSIDE RISK

The Fed hiked rates by 25 bps earlier this month to a target range of 4.5% to 4.75% and is expected to continue in quarter-point increments for now.

Mester expects too see "meaningful improvement in inflation" this year as higher interest rates drag growth below-trend and cools labor demand.

The good news is slower employment growth and a rise in the unemployment rate could come mainly from firms deciding not to add to their payrolls rather than cutting their staff, she said, noting businesses in the Cleveland Fed region have said they plan to do all they can to retain workers through the slowdown given how hard it was to hire them in the first place.

However, there's a risk that inflation could end up being much more persistent than current projections, despite the FOMC's actions, Mester said, citing new research by economists at the Cleveland Fed. That "inform[s] my view that the risks to inflation remain on the upside," she said.

"Further monetary policy action is needed to ensure that inflation is on a sustainable downward path to 2%."