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Fed's Brainard says soft inflation may warrant rate rethink

Wednesday, May 31, 2017 - 06:28

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Federal Reserve Governor Lael Brainard said soft inflation could cause her to reassess the path forward for monetary policy should it linger, even as the global economic outlook brightens and US growth looks poised to rebound.

[WASHINGTON] Federal Reserve Governor Lael Brainard said soft inflation could cause her to reassess the path forward for monetary policy should it linger, even as the global economic outlook brightens and US growth looks poised to rebound.

"If the soft inflation data persist, that would be concerning and, ultimately, could lead me to reassess the appropriate path of policy," Ms Brainard said in prepared remarks Tuesday. She said her baseline expectation is that "it likely will be appropriate soon to adjust the federal funds rate" and start shrinking the balance sheet.

Ms Brainard's remarks underline a puzzle facing the US central bank. Joblessness has fallen to a post-crisis low and consumer confidence is strong, yet price pressures have cooled, which could make the Fed's coming discussions more complicated. Policy makers lifted rates in March and have penciled in two more 2017 rate increases, and investors expect the first of those to come in June.

"I see some tension between signs that the economy is in the neighborhood of full employment and indications that the tentative progress we had seen on inflation may be slowing," Ms Brainard said.

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"If the tension between the progress on employment and the lack of progress on inflation persists, it may lead me to reassess the expected path of the federal funds rate in the future, although it is premature to make that call today."

Commerce Department data on Tuesday showed that the Fed's preferred price measure rose 1.7 per cent in April from a year ago, down from 1.9 per cent in March and 2.1 per cent in February. Core inflation - which strips out volatile oil and food costs - also slowed to the weakest annual pace since 2015.

That said, Ms Brainard argued that if the economy evolves as expected, "the federal funds rate will likely approach the point at which normalisation can be considered well under way before too long, when it will be appropriate to adjust balance sheet policy."

Balance-Sheet Unwind

The Fed is discussing how and when to shrink its US$4.5 trillion balance sheet. At its May meeting, nearly all officials "expressed a favourable view" of a staff-presented general approach to shrinking the balance sheet that would involve gradually increasing run-off caps every three months. The caps would would start off low and eventually reach fully phased-in levels, which would then be held in place until the size of the balance sheet was normalised.

Ms Brainard, who said that rate increases and balance sheet roll-off are essentially substitutes for one another, suggested Tuesday that the Fed won't preset an ending level for the balance sheet.

"It is difficult to know in advance with any precision how low reserves can be allowed to drop," she said.

"That minimum level will depend on the structural demand for reserves and the short-term variability in the demand for and supply of reserves." Ms Brainard is a long-time monetary policy dove who often points to risks in the global outlook, but she took a more optimistic view on the international economy in her remarks.

She also said that the US could see a boost from fiscal policy if President Donald Trump's proposed tax cuts were to take effect, though there's uncertainty about the magnitude and timing of any changes.

Debt Limit

In addition, she flagged the debate around the US debt limit as a potential pitfall for her outlook. The federal government will run out of ways to stay under the borrowing limit in the second half of this year unless Congress votes to move it higher.

"There is also important uncertainty about the deliberations over the debt limit, which are likely to garner increasing attention in the early fall and will factor into my considerations of risks to the outlook," Ms Brainard said.

During a question-and-answer session after the speech, she indicated that the depressed level of the neutral rate of interest - which neither stokes nor slows the economy - was another reason to exercise policy caution.

"I do believe that the neutral rate is very low, that we are not far at all from neutral, and I don't have a strong amount of confidence that it's going to rise rapidly from where we are today," she said.

"That does carry with it a set of implications for how do we achieve our 2 per cent objective, that is symmetric, and how do we achieve it on a sustainable basis."

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