Fed’s Daly: ‘good reasons’ for more tightening, or a pause

By Ann Saphir

(Reuters) -San Francisco Federal Reserve Bank President Mary Daly on Wednesday said that while U.S. economic strength, labor market tightness, and too-high inflation suggest the Fed has “more work to do” on rate hikes, other factors including tighter credit conditions could argue for a pause.

“Looking ahead, there are good reasons to think that policy may have to tighten more to bring inflation down,” she told the Salt Lake Chamber in Salt Lake City, Utah. “But there are also good reasons to think that the economy may continue to slow, even without additional policy adjustments.”

It’s the first time Daly has spoken since the failure of two banks last month rattled confidence in the banking sector and raised the specter of sharply tighter credit conditions that could slow the economy quickly.

The Fed raised its benchmark lending rate last month by a quarter-of-a-percentage point to the 4.75%-5.00% range. While noting the possibility of a pullback in bank lending that could slow the economy, it also cited the risks from continued too-high inflation, which by the Fed’s preferred measure is running at more that twice the central bank’s own 2% goal.

The Fed is widely expected to raise rates again when it next meets, on May 2-3, capping a rate-hike campaign that began in March 2022 when rates were near zero.

“While the full impact of this policy tightening is still making its way through the system, the strength of the economy and the elevated readings on inflation suggest that there is more work to do,” Daly said. “How much more depends on several factors, all with considerable uncertainty attached to their evolution.”

A government report on Wednesday showed consumer prices rose 5% in March from a year earlier, the slowest pace in nearly two years. Daly called it directionally “good news” although still too elevated, and said she want to see an easing in underlying services inflation, excluding housing, before feeling confident that inflation is ebbing.

Even so, she said, the Fed does not need to keep tightening policy until inflation gets all the way to 2%, in part because the rate hikes take about 12 months to make an impact on the economy. And because the public continues to expect inflation will eventually fall back to 2% – a phenomenon known as “anchored” expectations – the Fed does not have to move as aggressively and can take a couple of years to reach its inflation goal, she said.

Banking stress

Daly’s two-fisted characterization of the Fed’s next policy move underscores how critical the coming few weeks of economic and credit data will be.

For the most part Fed policymakers, including Richmond Fed President Thomas Barkin in remarks earlier on Wednesday, have kept the focus on high inflation even as they say they are monitoring credit conditions.

Just one policymaker, Chicago Fed President Austan Goolsbee, has called for “patience” in the wake of banking stress ahead of the Fed’s May meeting.

One of the two banks that failed last month, Silicon Valley Bank, did so after examiners at Daly’s regional Fed bank had repeatedly raised red flags over liquidity risk and bank management in confidential citations to its board of directors and executives.

The Fed Board in Washington oversees supervision of large regional banks like SVB, and Fed Vice Chair Michael Barr is undertaking a review of what went wrong to be published on May 1.

Daly said that with the Barr report still pending, it would not be appropriate to comment on whether SVB’s supervisors had done enough to prevent SVB’s failure.

The banking system, she said, is sound and resilient, and U.S. regulator actions demonstrate that “we are committed to ensuring that all deposits are safe.”

(Reporting by Ann Saphir; Editing by Chizu Nomiyama and Leslie Adler)