Fed Split on Rate Hikes Deepens as Five Years of High Inflation Tests Patience

Lorie Logan, president and chief executive officer of the Federal Reserve Bank of Dallas. Photo by Jorge Salgado /Photographer: Jorge Salgado/Bloo

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(Bloomberg) — Five years of high inflation is testing the patience of Federal Reserve officials and showcasing a split between those willing to wait before hiking interest rates and those who say time is running out. 

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Recent comments from policymakers suggest there’s a broader minority who see a case for raising rates soon after the Fed held its benchmark rate steady last month. Some non-voting members of the Federal Open Market Committee sided with three dissenters who preferred a modest increase. Others across the majority say it’s still possible the inflation will cool on its own — though their patience to look through price shocks is wearing thin.

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It’s an all familiar crossroads for central bankers: hike too soon at the risk of weakening the labor market, or wait too long and see price pressures becoming entrenched. The surprise decline in July payrolls in Friday’s jobs report did little to clear up the debate.

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“The data has been ambiguous on which one of these stories is actually playing out,” said James Egelhof, chief US economist at BNP Paribas. There’s “increasing pressure” for the Fed to act, he added, in light of the lack of significant progress on inflation.

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Employment declined in July and hiring was lower than previously thought in the prior two months, renewing concerns about potential softness in the labor market. Speaking after the report, Richmond Fed President Tom Barkin said the labor market appears to remains in “weak balance,” similar to where it has been over the past year and a half.

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The attention is now turning to inflation data to be released ahead of the Fed’s September gathering, including a consumer-price report due next week. 

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Officials see inflation easing back to their 2% target by 2028, according to projections released in June. Yet, with the consumer price index at 3.5% in June and the central bank’s preferred measure of inflation at 3.3%, excluding food and energy, concerns around officials’ ability to get there are mounting. 

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The discussion among policymakers, already on full display, will be fleshed out in the weeks leading into the Fed’s annual economic symposium at Jackson Hole, Wyoming. Chairman Kevin Warsh will then take the main stage, with investors carefully looking into his speech for clues he has so far refused to give on the future path for interest rates. 

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To Hold, to Hike

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Fed officials have chosen to hold their benchmark rate steady this year even after import costs spiked from changes in trade policy and energy prices soared due to the war in Iran. Some have suggested rate hikes might not be the right way to respond to what are likely temporary price shocks, given the time it takes monetary policy to affect the economy.

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Claudia Sahm, chief economist at New Century Advisors LLC and a former Fed economist, said that is the tension Fed officials are facing right now as they struggle to distinguish the cyclical factors influencing inflation and employment — which can be addressed through interest rates — from the structural shifts they have little control over.

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“The Fed’s tools are best suited for smoothing out the business cycle and what’s really driving the shifts we see in the aggregate data is a lot of structural shifts under the hood,” Sahm said. “The Fed’s tools aren’t best suited for that.”