Fed's Mester: Will need "compelling" drop of inflation to slow rate hikes

By Howard Schneider

AMELIA ISLAND, Fla. (Reuters) - Inflation will need to show a "compelling" slowdown before the Federal Reserve can consider pausing its interest rate increases, Cleveland Federal Reserve President Loretta Mester said Tuesday, with the risks currently pointed towards a tougher fight to bring the pace of price increases under control.

"I would need to see monthly numbers coming down in a compelling way before I would want to conclude we could now rest," Mester said in an interview with Reuters on the sidelines of an Atlanta Federal Reserve bank conference.

Between the Ukraine war, continued coronavirus lockdowns in China, and other factors "the risks to inflation are skewed to the upside and the cost of allowing that inflation to continue is high," Mester said, an argument for the Fed "doing more upfront rather than waiting."

The Fed is expected to approve half point increases to its short-term policy rate in June and July, "then we have to see," how inflation is behaving and debate how much higher rates may have to move, Mester said.

New government data on Wednesday is expected to show consumer prices continued rising more than 8% on a year over year basis last month, but may have slowed a bit compared to March - a possible sign that inflation has hit a peak.

Fed policymakers have set a 2% inflation target using a separate measure that is running about three times the target level. They began raising interest rates in March to try to cool consumer spending and bring the demand for goods and services more closely into line with what a stretched economy can produce.

Mester's comments point to a debate still to come over how different policymakers will evaluate incoming data, how much progress they will need to see on inflation to slow or pause further rate increases, and how much of a slowdown in the rest of the economy may be needed to cool the strongest price increases in 40 years.

Other Fed officials this week cautioned that demand could fall off fast as interest rates rise, a reason to be careful in raising rates.

Mester said she was open to the possibility that "excess demand" falls off faster than expected, or that world supply chains improve more quickly.

But at this point she said she expects the Fed's policy rate will have to move beyond the 2.5% level she regards as "neutral," and to a level that would begin to restrict the economy and likely cause the unemployment rate to rise from the current low level of 3.6%.

Even then, she said, she did not expect the Fed to fully win its fight over inflation this year or next, only to get back on the right path.

"I don’t think it will get back to 2% next year. But it will be well on its way, in the range of two and half percent but moving in the right direction," she said. "And given where the economy is and all the factors affecting inflation that are outside of our realm, that is acceptable to me."