MNI INTERVIEW (RPT): Risk Inflation Stays High Longer-Garriga

(Repeats article first published on July 14)

The risk that U.S. inflation continues to stay elevated is rising amid a worsening global energy crisis and fears that Shanghai will be forced into another Covid lockdown, Federal Reserve Bank of St. Louis research director Carlos Garriga told MNI.

"The FOMC has been clear: we need to have solid signals of inflation not only moderating but getting back to our target and remaining near target," he said in an interview. "All the news we're getting from the global economy points in the opposite direction. Risks are elevated to the upside. The blockage of the gas pipeline to Germany, discussions on additional lockdowns in China which will put additional pressure on supply chains. A lot of businesses will have to factor this into their operation strategy."

Garriga made his remarks before the Labor Department released its latest CPI report Wednesday, showing consumer price inflation accelerating to a faster-than-expected 1.3% in June from a month earlier and 9.1% over the past 12 months, the highest since 1981. Markets are now pricing in a 45% chance the Fed will opt to raise interest rates by 1 percentage point later this month rather than the 0.75 pp move discussed in recent weeks.

"In 1970s and '80s, we saw big waves of inflation that peaked and bounced back. The data is volatile, and we're not going to be dependent on one data release," Garriga said. "We need a continuous set of readings where the trend is really clear. With the latest global news, that could be delayed."

HOUSING SLOWDOWN

The Fed's ability to control globally-driven inflation is limited, but "the belief is in the medium term, there will be a convergence between headline and core, especially if the short-term deviations due to specific international shocks tend to be less persistent," Garriga said.

A slowing in credit-sensitive domestic sectors like housing and autos will rein in key components of core inflation like shelter that have historically remained elevated for longer than energy prices, and Garriga said he's following housing permitting, supply and sales data closely. (See: MNI INTERVIEW: No Sign of Slowing in Inflation - Fed's Dolmas)

"We could see rents with two-digit growth rates. That’s more likely to be persistent than energy and food prices determined at a global level," he said. "I suspect we’ll be using a lot of core information to determine to what extent the factors that we believe are more under our control are coming down to target, but that doesn’t mean we don't have a lot of work to do on headline inflation."

PRICE EXPECTATIONS FALLING

The FOMC's aggressive stance on fighting inflation, including its 75-basis-point rate hike last month and projections of a steeper policy path has helped lower inflation expectations, Garriga said. (See: MNI INTERVIEW: High Bar For Fed To Back Off Big Hikes- Athreya)

"We’re seeing a big adjustment on inflation expectations. They’ve been coming down, and I think that's highly connected with the economic outlook," Garriga said. "Managing the medium-run expectations about inflation is a necessary requirement to managing medium-run inflation, so it's a welcome development."

Heightened uncertainty and recession fears could drive "a bit of a slowdown" in consumer spending, he said, though he dismissed concerns that rapid Fed tightening will stifle growth and send unemployment soaring.

"We have the strongest labor market since the late 1990s," he noted. Credit-sensitive sectors in particular will feel the effects of tightening financial conditions and see employment slow or fall, but "we may see a small readjustment in the labor market without having a big spike in unemployment like in past recessions."