MNI (RPT): STATE OF PLAY: FOMC To Signal March Hike, Debate QT

(Repeats article first published on Jan. 25)

The Federal Reserve on Wednesday is expected to conclude its pandemic-era asset purchase program and signal a March start for interest rate increases this year to rein in high inflation.

The FOMC will also continue hammering out a plan to reduce its securities portfolio soon after rate hikes begin, potentially around mid-year -- earlier than in the 2015 hiking cycle and at a more aggressive pace.

With the labor market nearing full employment and consumer price inflation breaching 7%, some Fed officials have already endorsed a March liftoff for rates, even as data have yet to detail the extent of slowdown caused by the highly-contagious Omicron coronavirus variant.

The FOMC's December estimate for three interest rate increases this year already looks outdated, and even market expectations for four hikes this year may be too conservative, former Fed economists told MNI.

MOMENTUM IN INFLATION

Pandemic-related price hikes have proven more stubborn than most forecasters expected and are set to run above the Fed's 2% average target for as long as the central bank maintains an accommodative stance.

Some supply chain kinks appear to be clearing up, but inflation in core services categories such as housing is worsening. CoreLogic forecasts owners' equivalent rent will likely double to 7% by the end of the year, which alone would keep core CPI elevated at around 4% even if every other price category returned to 2%.

Firms also anticipate sharply higher wage growth over the next 12 months, prompting worries over a wage-price spiral.

"When you have momentum in inflation it may be hard to stop and they may be forced to do much more than they currently expect," former IMF chief economist Olivier Blanchard told MNI.

QT AS TIGHTENING TOOL

Interest rate increases are seen as the main tool to fight inflation, but officials are also keen to shrink the Fed's balance sheet more aggressively as another way to tighten financial conditions.

Runoffs could start after two or three rate hikes, with the maximum cap on reinvestments above the peak QT rate of USD50 billion a month in 2018, former Fed economists told MNI.

The ultimate effect of QT on inflation could be modest, the economists said, but the record speed of the recovery means the pace of balance sheet normalization, like rate hikes, will need to be stepped up.