Fed's Rosengren warns of overheating risks and seeks more hikes

[WASHINGTON] Federal Reserve dove-turned-hawk Eric Rosengren warned the US central bank was in danger of lifting its foot off the policy accelerator too slowly, and called for more aggressive action to prevent the economy from overheating.

The Boston Fed president urged his colleagues to raise interest rates three more times this year and consider starting to shrink the central bank's balance sheet after their next hike. Speaking in South Burlington, Vermont on Wednesday, he said this was necessary to avoid pushing unemployment too far below estimates for its lowest sustainable level.

The median projection from Fed officials in March, their most recent quarterly forecast, pointed toward two additional rate increases this year. The Federal Open Market Committee has also begun discussions on when and how to trim its balance sheet, but signalled it would kick that effort off, at the earliest, in the fourth quarter.

Recent declines in joblessness, which hit 4.4 per cent in April, along with an outlook for continued growth above the economy's long-term potential "would represent an unsustainable, overshooting pace, and provides an important rationale for continuing the process of normalisation of monetary policy that is currently underway," he said.

June Meeting

Mr Rosengren can deploy these arguments at the June meeting of the FOMC to persuade the committee to raise rates for the third time in six months. He'd probably be joined by Cleveland Fed chief Loretta Mester - who warned Monday the Fed should stick to its current pace of rate moves to prevent the economy from overheating - as well as Kansas City's Esther George, who has consistently called for higher rates.

Mr Rosengren shifted to the more hawkish wing of the FOMC in 2016 after years of being a forceful advocate for keeping rates low. He has voiced concern over shooting too far past estimates of full employment and over the risks posed by rising commercial real estate prices. He's scheduled to vote again on the FOMC in 2019.

Mr Rosengren said Wednesday that he - along with most economists in the Blue Chip Economic Indicators survey - expects above-potential growth over the next year, pushing unemployment even lower.

"Along with a gradual reduction in the level of the balance sheet, it would still be reasonable to have three rate increases over the remainder of this year, assuming the economy evolves like my forecast envisions," he said.

Fed officials made quarter-point moves in December and March that lifted the target range for the federal funds rate to 0.75 per cent to one per cent. The FOMC left rates unchanged in May, but signalled members were not significantly concerned by weak growth in the first quarter.

Mr Rosengren agreed with that assessment, calling a dip in consumer demand "transitory".

'Consumption-Led Recovery'

"My expectation is that consumption will re-emerge in the second quarter and we will continue to have a consumption-led recovery," he said.

He dismissed concerns that tepid loan growth was a sign of underlying weakness in the economy. He said it more likely reflects increased bond issuance and non-bank lending as substitutes for bank lending.

Mr Rosengren also noted that global risks appeared to have waned this year, reflected in higher stock prices in the US, Europe and emerging markets, as well as in rising forecasts for global growth.

He repeated his view that the Fed should reduce its US$4.5 trillion portfolio of bonds at a pace that is slow enough "so that the reduction in the balance sheet is not disruptive, and so that it can occur largely in the background." Noting that one more hike would push the fed funds rate above one per cent, he said "that seems an appropriate point to consider beginning a very gradual normalisation of the Federal Reserve's balance sheet."

In answering questions from the audience, Mr Rosengren added that any fiscal stimulus that emerges from Congress and the Trump administration, if it further tightens labor markets, "would cause us probably to raise interest rates a little more quickly".

BLOOMBERG