MNI INTERVIEW: Inflation Risk To US Soft Landing-IMF’s Adrian

Stubborn U.S. inflation could prevent the Federal Reserve from cutting interest rates as quickly as investors expect, raising the risk the economy will slow more than expected or that financial turmoil might resurface, IMF financial counselor and director of the Monetary and Capital Markets Department Tobias Adrian, told MNI.

Adrian said the Fund’s baseline is for a global soft landing where some countries might flirt with contraction but not nearly enough to keep the world economy from expanding. Still, stubborn inflation readings such as the latest reports from the United States make clear the risk from price pressures has not been fully extinguished, he said.

“One of those risks that were realized last week were inflation prints above expectations. The risk of having more persistent inflation that may lead to a repricing of interest rates, that is certainly one risk,” said Adrian, who spent more than 13 years at the New York Fed, in an interview in his offices at the Fund’s Washington headquarters.

Both CPI and PPI reports for February showed hotter-than-expected readings, with core consumer prices still up 3.8% on an annual basis.

“If you have additional inflationary shocks, you have to tighten demand, you might go into a territory where a more significant slowdown of real activity would be necessary to get inflation down. Stagflation risk is coming back into focus.”

Key sources of concern on inflation include the stickiness of services prices, which are heavily dependent on labor costs, but also the risk of further shocks, geopolitical or otherwise, that could send commodity and energy prices ratcheting back up. (See MNI INTERVIEW: Fed Patient On Cuts As Inflation Sticky-Hetzel)

FINANCIAL STABILITY THREAT

Inflation is also a possible threat to financial stability, Adrian said, because a sharp adjustment of market expectations for an eventual round of rate cuts later this year could upend the ability of banks and other financial firms to cope.

“At that one point we may face not only higher interest rates but also some pressure in terms of credit.”

The Fed is widely expected to keep interest rates on hold at a 23-year high of 5.25-5.5% this week, and officials have taken pains in recent weeks to dissuade investors that rate cuts are imminent. Policymakers say they need greater confidence that inflation is heading sustainably back to their 2% target before embarking on a new rate-cutting cycle.

Adrian said Fed policymakers should not forget the contribution of ongoing fiscal support to the economy’s strength. He said it’s important to look at a wide array of measures to determine the extent of policy restrictiveness that monetary policy is delivering – including fiscal policy itself.

“You certainly want to look at monetary policy in the context of fiscal policy as well,” he said. “The fiscal impulse continues to be relatively strong and it could get stronger over time, say next year or so, in terms of net expenditures.”

A softening of economic activity, including a less ebullient labor market and weaker retail sales, are signs that monetary policy is at least restrictive to some extent.

“Is it enough I think is one relevant question,” he said.