Fed's Bullard warns of "violent" reaction if markets misjudge rate path

[LONDON] Unless investors start believing that US interest rates are on the way up there could be a potentially extreme market reaction when they actually do rise, Federal Reserve policymaker James Bullard said on Tuesday.

Mr Bullard said a first rate hike "sometime in the summer" would still leave monetary policy extremely accommodative, and that market expectations should be better aligned with those of the Fed considering the current "boom time" for the US economy.

"I think reconciliation between what markets think and what the committee thinks will have to happen at some point," Mr Bullard told reporters at London's City Week financial conference. "That's a potentially violent (encounter) ... and I am concerned about that. I am hopeful that markets and the policy committee can come to some kind of meaningful meeting of the minds in the coming months and quarters."

The Fed has been inching towards its first interest rate hike in almost a decade for over 1-1/2 years, but analysts are still trying to guess the exact timing.

Expectations were pushed back again last week after the Fed lowered its growth forecasts and its chair, Janet Yellen, raised concerns about the strength of the dollar.

Mr Bullard has long called for the Fed to start the process of lifting rates back to more normal levels but he is not one of the bank's voting members this year.

"Zero is no longer the appropriate interest rate for the US economy," Mr Bullard said during an earlier panel session, arguing that with economic growth on track to be above 3 per cent this year and unemployment falling towards 5 per cent, the time was right to lift rates.

The dollar, however, has seen its sharpest fall in years and US government bond yields have dropped since what markets read as last week's more balanced tone from the Fed.

Mr Bullard said he was not more dovish than previously. Removing the word 'patient' from the Fed's policy statement with reference to rate increases was an important step and give more meeting-by-meeting "optionality" to make changes.

He said that changes to the bank's "dot plot" which shows when the bank's members think rates will rise, may also have given a slightly deceptive view. It may have just been a case that members shifted dots purely because rates were not going to rise at that meeting or in April.

Mr Bullard also said that negative bond yields in core European government bond markets were "somewhat surprising" although this was helping suppress US rates and therefore aiding the US economy, which in turn could drive rate rises.

REUTERS