Blog Rising inflation pressures justify higher rates

Rising inflation pressures justify higher rates
Gradually rising US inflation justifies gradual increases in official interest rates - 50 basis points in 2016 and further tightening in 2017 and 2018, Chicago Fed President Charles Evans said in a keynote speech at the AIC 2016 on Tuesday.

“Currently I believe economic conditions imply it would be appropriate to take two more rate hikes this year and then follow a gradual path of rate increases thereafter,” Evans said.

Evans cited the current Fed projection, known as the dot chart, which shows policymakers believe the fed funds rate target should rise toward 3 percent by 2018 - even as market forecasts remain closer to 1 percent.

The strengthening US labor market, low energy prices and accommodative monetary policy will ultimately boost consumer spending, though slow global markets and the recent strengthening of the dollar prevent the US economy from firing on all cylinders.

Low rates have helped stimulate auto and home sales, underpinning spending that will gradually push US GDP growth to 2-2.5 percent in 2016 and nudge inflation toward the Fed’s 2% target over the next three years.

“All of these factors should continue to generate fairly solid increases in consumer spending, particularly given my assumption that interest rates will stay quite low for some time,” Evans said.

The increase in inflation would reflect the dissipating effects of energy price declines, the appreciating dollar and wage growth from the improving labor market, Evans said.

“However, I am a bit uneasy about this forecast,” Evans added, noting that it was “too early to tell” for sure whether increased inflation would persist.

Asked if current low rates were hurting savers, in addition to retirees, and pension funds that pay annuities, Evans noted that the Fed is not the only factor holding down fixed income yields. He cited slow growth worldwide, prompting increased savings and strong demand for safe haven assets, such as US Treasuries.

“There is much afoot that is not just monetary policy in the US, Evans said. “I know that a lot of people have been hurt by the change in compensation for accumulated savings, and in a better world, with better growth, maybe that will turn around.”

Watch the full replay of Charles Evan’s keynote address