US Fed has room to raise interest rates

SAN FRANCISCO (Reuters) – The Federal Reserve has room to raise interest rates over the next couple of years without slowing economic growth, Fed governor Lael Brainard said on Wednesday, suggesting that monetary policy would likely continue to tighten for some time.

With economic growth strong, unemployment at 3.9 percent and inflation near the Fed’s 2.0 percent goal, further gradual interest rate rises are likely to be appropriate over the next year or two, Fed governor Lael Brainard told the Detroit Economic Club.

Her phrasing echoed recent comments from Fed chair Jerome Powell that had already begun to lay the groundwork for a longer-than-expected rate-increase cycle.

But Brainard went further, laying out in detail the thinking behind a rate hike cycle that could continue “over the next year or two,” rather than pausing next year as policymakers including the Dallas and Atlanta Fed chiefs have said could make sense.

In her view, outlined for the first time in the speech, stimulus from tax cuts and government spending under US President Donald Trump are lifting the short-term neutral level of interest rates, a theoretical level of borrowing costs that allows investment and hiring to continue unimpeded in a healthy economy.

A rise in the neutral level gives more headroom for the central bank to lift rates without slowing growth.

“With fiscal stimulus in the pipeline and financial conditions supportive of growth, the shorter-run neutral interest rate is likely to move up somewhat further, and it may well surpass the longer-run equilibrium rate for some period,” Fed governor Lael Brainard said.

It is this shorter-run neutral rate, and not the longer-run neutral estimate that is published each quarter by the Fed, that is the “relevant benchmark” for monetary policy, Brainard said. The Fed’s most recent estimate of the longer-run rate is 2.9 percent, about one percentage point higher than the Fed’s current policy target rate.

Most observers have taken this longrun rate to be a ceiling for Fed interestrate rises beyond which monetary policy would become restrictive, hindering economic growth.

Brainard’s assessment suggests the Fed’s current round of interest-rate hikes could continue longer, and top out higher, without impeding the economic expansion.