- Fed policymakers leaning to 75 basis-point hike this month
- FOMC voter Bullard calling for 4.0% policy rate by end-2022
- ECB faces dilemma as Russian gas cuts dampen economic outlook
Federal Reserve policymakers are trying to walk a tightrope between mounting a credible defense against US inflation and not tipping the economy into a full-blown recession.
The blowout 9.1% reading of the consumer price index last week created apprehension among investors that the Fed would overreact and raise the Fed Funds overnight rate by a full percentage point.
Fed Governor Christopher Waller, the former chief economist at the St. Louis Fed, cautioned against such a drastic move.
“You don’t want to really overdo rate hikes. A 75-basis-point hike is huge,” Waller told an audience at an economic conference in Victor, Idaho.
“Don’t think because you’re not going 100, you’re not doing your job.”
Earlier in his talk, Waller had said he would support a 75-basis-point hike given the current data—including that high CPI reading—at the July 26-27 meeting of the Federal Open Market Committee, barring incoming data that would prompt a bigger hike.
The 75-point hike would bring the policy rate to 2.25 to 2.50%, which Waller considers close to the neutral rate the Fed is targeting. Then he would look for signs that inflation is going down before the September 20-21 meeting.
Raphael Bostic, the head of the Atlanta Fed, also cautioned on moving too fast with rates. “Moving too dramatically can undermine a lot of those things that are working well,” he said at a forum of the Tampa Bay Business Journal. Bostic is not a voting member of the FOMC this year, but like all regional bank chiefs, he takes part in the committee’s discussions.
St. Louis Fed President James Bullard, who is a voting member, on Friday raised his target for the end of the year to near 4.0% range, from his previous target of about 3.5%. Earlier in the week, though, he had said he favored a 75-basis-point increase in July.
The FOMC has three more meetings in 2022 after the one in July, so plenty of time to raise rates to 4% if it limits the hike this month to three-quarters of a percentage point.
The situation in Europe is different. Inflation is also surging there, but it is largely driven by a sharp spike in natural gas prices in the wake of the Ukraine war as Russia cuts its deliveries. Rate hikes by the European Central Bank would have little effect on gas prices while energy shortages are already dampening the economic outlook.
The ECB is holding its policy meeting this week, and investors are expecting a rate hike of at least 25 basis points, but the divergence with US rates has already brought the euro to parity with the US dollar.
Finland’s central bank governor, Olli Rehn, said on Friday that the ECB could still normalize policy gradually enough to avoid a recession. His Dutch counterpart, Klaas Knot, noted that rate hikes at this meeting and later in the year would coincide with slower European growth anyway.
ECB policymakers have been slow to start raising rates, and investors are skeptical that they will push hard given the energy situation and the slowing economy. Although a September hike has been factored in financial markets, there is little certainty about what will follow even if inflation continues to rise.
The ECB also plans to amplify its measures to keep spreads in government bond yields from widening too far by buying up weaker bonds, raising the price, and lowering the yield for countries like Italy and Greece.
However, a political crisis in Italy has thrown a wrench in those plans. The populist Five-Star Movement, which belongs to the unity government of Prime Minister Mario Draghi, boycotted a confidence vote in the Senate last week and prompted Draghi to tender his resignation.
Italian President Sergio Mattarella has declined to accept it so far, but the government could collapse this week and trigger early elections, which would paralyze Italian policy for months and impact bond markets.