U.S. Fed’s balancing act could see June rate cut in play even with sticky inflation

WASHINGTON — Federal Reserve Chair Jerome Powell says the central bank is not growing more tolerant of higher inflation even though the latest policymaker projections raised the inflation outlook for the year without triggering a tougher monetary-policy response.

But former Fed officials and other analysts see Powell nevertheless approaching a difficult moment trying to reconcile competing economic risks, a divided group of Fed policymakers, and a public now expecting interest rate cuts to start in June.

Upcoming data may well support a June rate reduction if inflation declines convincingly towards the Fed’s 2 per cent target between now and then, resuming a trend that encouraged policymakers last year to cap the federal funds rate at the current 5.25 per cent-5.50 per cent and lay the groundwork for easing to begin this year. Others see a slowing economy and weakening job growth on the horizon, pushing the Fed to cut in order to support the labor market.

Yet even if inflation proves more persistent than expected in coming weeks and the economy remains strong, the Fed could still proceed with a June cut by framing it as a potentially one-off adjustment rather than the locked-in beginning of a series of reductions, former Fed Vice Chair Richard Clarida, now a global economic adviser to bond giant PIMCO, wrote this week in assessing the pivotal moment central banks face in their policy communications.

The upfront justification of rate cuts expected to start this summer, Clarida said, would be that policymakers are simply keeping rates in step with the decline in inflation seen since last year, and could cut further as long as inflation continued to fall.

But “if inflation...does not follow the forecasts and becomes entrenched at a plausible 2.5 per cent...the central banks would likely pause their rate cut cycles,” Clarida wrote, and depend “on their belief that by keeping policy restrictive long enough, they can credibly forecast inflation returning (eventually) to the 2 per cent target.”