By Howard Schneider
WASHINGTON, May 6 (Reuters) – Federal Reserve officials said on Wednesday the ongoing U.S.-backed war with Iran is raising the risk of a sustained inflation shock, with continued high oil prices and developing concerns about problems with global supply chains.
Chicago Fed President Austan Goolsbee said business executives told him shortly after the conflict began on February 28 that a short rise in oil prices would not be a problem, but “if this was going to be month after month of really extended high oil prices, they would start to feel pretty intense pressures on the supply chain,” reminiscent of what helped drive the inflation surge during the COVID-19 pandemic.
“You’re starting to see some of these problems developing,” Goolsbee said in a video call with journalists after participating in a Milken Institute conference in Los Angeles. “The longer it goes, the more you’re going to have these problems, because they’re using up what stock of inputs they had” for industrial chemicals and other inputs whose distribution has been disrupted, while sustained high fuel prices are feeding through to shipping and other costs.
While there was initial concern the war would hurt U.S. job growth and demand while also leading to higher prices, “It has not yet been a stagflationary-direction shock,” Goolsbee said. “It has just been an inflationary shock. And the longer that continues, the more nervous that makes me.”
With inflation lodged about a percentage point above the Fed’s 2% target and expectations it may move higher, investors see little chance the U.S. central bank will cut rates for perhaps another year or more.
Speaking separately, St. Louis Fed President Alberto Musalem said the risks to monetary policy have shifted towards higher inflation, possibly requiring interest rates to stay on hold “for some time,” and perhaps even move up.
“Inflation is running meaningfully above our target,” Musalem said in comments to a Mississippi Bankers Association event in Fairhope, Alabama. “We have risks both on the employment side and on the inflation side. In my understanding, risks have been shifting towards … the inflation side,” adding weight to expectations that the Fed would at least keep its policy rate on hold.
While there were “plausible scenarios” in which the Fed could cut rates, if demand slowed and the unemployment rate rose, Musalem said the same was true at this point about the central bank possibly hiking borrowing costs.
“There’s a lot of uncertainty right now, and it’s important to see how things settle,” said Musalem, noting that inflation pressures were moving beyond the impact of tariffs and high oil prices due to the war in the Middle East.
MOVEMENT WITHIN FED TOWARD IDEA OF POSSIBLE RATE HIKES
Oil prices have been volatile, spiking and falling amid news reports about progress – or lack of it – in ending the dispute. The global benchmark price dropped fast overnight on news of a possible settlement, but then rose back above $100 a barrel.
The average U.S. price of gasoline has risen from around $3 to more than $4.50 a gallon, according to motorist advocacy group AAA. A New York Fed measure of global supply chain pressure, meanwhile, jumped to the highest level since July of 2022, when manufacturing chains were still snarled from the pandemic and the world faced a systemic surge in prices.
“This is also underlying inflation that we need to worry about,” Musalem said, adding that business executives were telling him that higher prices for aluminum, helium, diesel fuel and other industrial inputs “will all be disruptive … There’s a confidence effect” that may suppress hiring even as it risks higher price increases.
The net result for the Fed may be an extended pause in any change to a policy rate that has been in the 3.50%-3.75% range since December, stalling what had been anticipated continued monetary policy easing and complicating incoming Fed Chair Kevin Warsh’s ability to deliver the rate cuts President Donald Trump has said he expects.
Musalem and Goolsbee are not currently voting members of the rate-setting policy committee, but their comments demonstrate what Fed Chair Jerome Powell said is movement at the “center” of the central bank towards the possibility that rate hikes might be needed to combat inflation risks.
The Personal Consumption Expenditures Price Index, used by the Fed to set its inflation target, rose to 3.5% in March from 2.8% in the prior month, while underlying “core” inflation that excludes among other things the recent swings in energy prices, rose to 3.2% from 3.0% in February.
The Consumer Price Index for April, due to be released next week, is expected to show a further acceleration.
The U.S. employment report for April, scheduled for release on Friday, is expected to show the unemployment rate remained unchanged at 4.3%, according to the consensus forecast of economists polled by Reuters.
(Reporting by Howard Schneider; Editing by Chizu Nomiyama and Paul Simao)
Comments