MNI INTERVIEW: Fed May Surprise With Balanced View After Cut

By Jean Yung

     WASHINGTON (MNI) - Federal Reserve officials could surprise markets with a

balanced tone on future policy moves next week, even as an increasing emphasis

on boosting inflation prompts them to cut interest rates by a quarter point,

former Atlanta Fed president Dennis Lockhart said in an interview.

     Despite recent data pointing to a resilient U.S. economy, global risks

argue for the first rate cut since the financial crisis, Lockhart told MNI this

week, adding that the Fed's ongoing review of how to achieve its inflation

target may already be leading to a more proactive policy stance.

     "A cut would be justified by the array of uncertainties and global risks,

the continuing inflation situation, and softening of inflation expectations by

some measures," he said. "The policy move may hold for some time or may be taken

back if a better than expected economy develops. They're likely to keep their

options open and not commit themselves in any way to a September move."

     Policymakers will be watching how global factors are likely to play out and

influence the domestic balance of risks, he added.

     Futures markets are now pricing 30 basis points of cuts next week and

another 18 bps at the September meeting.

     --INFLATION TARGETING FRAMEWORK

     Near-term policy moves may be driven more by sensitivity to inflation

dynamics than trends in the overall economy, Lockhart said. Data have been

mixed, but the anticipated rate cut is not a reaction to U.S. growth trends,

which are running close to longer-term projections.

     Instead, we could be seeing the impact of the Fed's year-long review of its

monetary policy strategy, tools and communications. Policymakers are mulling

whether it might be useful to target 2% inflation on average over a given period

rather than at a point in time.

     "I think the framework review combined with the data evidence have brought

the soft inflation and arguably deteriorating inflation expectations front and

center in their thinking," Lockhart said.

     "It will likely take several more months until the operating framework

discussion concludes, but some of the thinking that has been discussed may seep

into policymaking before the conclusion of the review."

     --FED CREDIBILITY

     While acknowledging that the Fed may conclude the consideration of its

framework with no formal changes to its approach to inflation, Lockhart noted

that an inflation-averaging approach has appeared to attract the most support

thus far.

     But he cautioned that any inflation make-up strategy would mean doubling

down on the Fed's credibility on inflation, which is already somewhat in doubt.

     "A shift to a make-up approach presupposes that the Fed can actually move

inflation higher," he said. "That does strike me as raising the stakes for the

FOMC."

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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