The US Federal Reserve is signalling that further rate rises may be needed as inflation remains above its 2% target, with policymakers’ forecasts suggesting price stability may not return until 2029.
That would leave the Fed struggling to meet the price-stability part of its mandate for eight consecutive years, as the economic impact of the conflict involving Iran adds to pressure from energy costs and strong growth.
Inflation had been easing at the start of the year as the initial impact of Donald Trump’s tariffs began to fade. But crude prices surged after Iran closed the Strait of Hormuz and attacked regional energy infrastructure in retaliation for US-Israeli strikes.
Oil exports have since recovered with the help of US military protection, but supplies of refined products including petrol and diesel remain tight. The resulting increase in pump prices has added to the strain on consumers.
At the same time, economic growth has remained strong as artificial intelligence companies known as hyperscalers pour hundreds of billions of dollars into the economy, adding to price pressures.
October’s consumer price index was hotter than expected and showed inflation spreading beyond energy into a wider range of goods and services. Chicago Fed president Austan Goolsbee described the figures as “borderline disturbing”.
Federal Reserve officials warn of further rate rises
Goolsbee said the central bank still needed to restore confidence in its ability to control prices.
“I believe that the central bank has definitely got work to do to continue to reestablish its credibility,” he told CNBC. “We’ve been above 2% for almost six years, and while it sometimes we were making progress, lately we’re not making any progress, and if anything, it’s going the wrong way.”
Fed governor Christopher Waller said a 50-basis-point increase should be considered at the December meeting if core consumer prices had risen by at least 0.3% in October. They increased by 0.3% month on month.
“Hiking only 25 basis points would put our credibility at risk, a risk I am not eager to take,” Waller said.
Lorie Logan, president of the Dallas Fed, separately said policymakers might be able to move more rapidly than implied by September’s quarter-point increase and October’s decision to hold rates. She warned that the current policy rate of 3.75% to 4% was too low and was adding to inflationary pressure.
The Fed’s September projections had already pushed back the expected return to 2% inflation to 2029, from 2028 in forecasts issued in June, as energy prices remained elevated.
Inflation has been above target since early 2021, following pandemic-related supply-chain disruption and large fiscal stimulus. Russia’s invasion of Ukraine then sent oil and gas prices higher, before Trump’s trade war and the conflict involving Iran created further shocks.
However, Fed chairman Kevin Warsh has argued that high inflation is a “choice”, indicating that external shocks should not be treated as a complete explanation for the prolonged increase in prices.
Policymakers are also concerned that a long period of elevated inflation could change consumers’ expectations and spending patterns, creating further upward pressure on prices. The longer inflation remains above target, the less willing central bankers have become to look through temporary increases.
Diane Swonk, chief economist and managing director at KPMG, said Fed hawks were coming together as inflation remained too high for too long and began moving higher.
“Fed is losing its inflation fighting credibility,” she said. “Consumers who rely mostly on wages, not their stock portfolios, are paying the price.”
The conflict involving Iran shows no sign of ending soon. Mr Trump has withdrawn repeated threats to resume major combat operations but has also rejected negotiations, saying the US does not need a peace deal with Iran.
“We’re just keeping it the status quo,” he told reporters on Monday.
If the conflict continues to keep energy supplies under pressure, the Federal Reserve may be forced to revise its inflation outlook again and take a more aggressive approach to interest rates.
