San Francisco Fed President Mary Daly said the U.S. economy is fundamentally strong, the labor market is stable and monetary policy is in “good conditions” and restrictive enough to put downward pressure on inflation without hurting the labor market.
But the oil crisis caused by the Iran war could extend the timeline for bringing inflation back to the Fed’s 2% target, potentially forcing the Fed into a pattern of holding rates steady, he told Reuters in an interview late Thursday. “There was work to be done before the oil price shock, and the oil price shock will only make the work take longer,” Daly said, noting that while the fall in oil prices after the US and Iran announced a ceasefire earlier this week has provided some relief, “no one knows how long that will last.”
The Fed has kept its short-term interest rate target in the range of 3.50% to 3.75% at both of its two meetings so far this year. Many Fed policymakers, including Mr. Daly, believed that tariff-related inflation would likely subside by the end of the year, allowing the central bank to resume rate cuts. She thought she might need a cut or two.
Then the Iran war broke out, and oil prices skyrocketed, pushing gasoline prices above $4 a gallon.
Oil shocks “prolonged inflation would push up inflation and push down growth. What we need to do as policymakers is to balance these risks and make the best decisions to achieve both goals as quickly and easily as possible.”
Daly said the risks to the Fed’s twin goals of full employment and price stability are balanced at this point.
She steps through what happens next.
“Scenario 1: The situation resolves quickly, the cease-fire is extended, the conflict is more or less over, oil prices return, businesses and consumers begin to notice that gas prices and other energy costs are coming down, and we are back on track: good growth, a stable labor market, and tariff removal that gradually lowers inflation,” Daley said. If this happens, he said, “a rate cut to continue the path to normalization would not be out of the question.”
But she’s also looking at another scenario. Even after the war ends, disruptions to oil transportation caused by the war could keep inflation high for a longer period of time than the Fed expected. “If that’s the case, then of course we’re going to just sit around until we know the job is done,” she said.
“I think the chance of a rate hike is less likely than the other two possibilities,” he said.
He said a prolonged conflict and sustained high oil prices would simultaneously push up inflation and slow growth, and the Fed would face complex calculations about how to respond.
“I think it’s critical to getting inflation back to 2%,” he said. “But if you do it at the expense of jobs, you’re unfairly putting families behind the eight ball.”
Daly spoke to Reuters on the eve of a government report that was widely expected to show consumer prices rose at the fastest pace in nearly four years last month.
“This is already showing up in the economy and the rise in CPI numbers should not be a surprise to anyone,” Daly said. People are paying high gas prices, farmers are concerned about high fertilizer prices and travel and tourism is depressed as people worry about the cost of cars and flights, she said.
“The new news is that the conflict can be stabilized, transport lanes can be opened, and we can start to return to a situation that seems more reasonable to people,” she said. “But you know, that’s the area of uncertainty.”
(Reporting by Ann Safir; Editing by Chizu Nomiyama)
