Federal Reserve Mester Says Rate Target Will Need to Surpass 5%

The Federal Reserve Headquarters is pictured March 21, 2023 in Washington, DC.

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Federal Reserve Bank of Cleveland President Loretta Mester said on Tuesday that the U.S. central bank likely has more interest rate hikes to come as recent turmoil in the banking sector has been contained.

To keep inflation on a sustained downward path at 2% and keep inflation expectations anchored, Mester said she sees monetary policy moving “a bit further into restrictive territory this year, with the federal funds rate exceeding 5% and the real federal funds rate remaining in positive territory for some time.”

“The precise extent to which the fed funds rate will need to rise from here and how long policy will need to remain restrictive will depend on how much inflation and inflation expectations fall, and that will depend on the extent of the demand slowdown, supply challenges are being resolved and price pressures are easing,” Mester said in a speech to a group of economists in New York. .

At the end of March, the Fed raised its rates by a quarter of a percentage point, between 4.75% and 5%. The decision was haunted by the troubles in the banking sector which led policymakers to say that a tightening of financial conditions would likely weigh on economic activity.

“I was very comfortable moving forward” with the rate hike, given that authorities had taken steps to manage the risks associated with problems in the banking sector, Mester said in remarks after his speech.

At the policy meeting, officials also forecast just one more rate hike for this year as the Fed continues to raise the cost of short-term borrowing in an effort to reduce inflation.

In his remarks, Mester, who did not vote on the Federal Open Market Committee this year, said: “My forecast is similar to the FOMC participants’ modal forecast released two weeks ago, although I see a somewhat more persistent inflation pressures than the median forecast among participants.

She also pushed back against the market’s view that the Fed will need to cut rates much sooner than central bankers currently expect. “Can I offer scenarios in which the Fed would cut rates? Yes. Is that my modal forecast? No.”

Mester said he was confident that the banking sector’s woes should finally be contained.

“The US banking system is strong and resilient,” she said. “The strains experienced by the banking system in March have eased, but the Fed continues to monitor conditions carefully and stands ready to take further action if necessary to ensure financial stability.”

In her remarks, Mester said she expects growth and hiring to slow and inflationary pressures to ease.

There should be a “significant improvement” in inflation, with price pressures declining from their current 5% year-on-year increase to 3.75% this year and 2% by 2025, Mester said.

She said growth is expected to slow to below-trend levels this year before picking up again next year. Unemployment, currently at 3.6%, is expected to reach between 4.5% and 4.75% by the end of 2023, she said.

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