San Francisco Federal Reserve Bank President Mary Daly stated that the U.S. economy's fundamentals are solid, the labor market is stabilizing, and monetary policy is in a "good place"—tight enough to exert downward pressure on inflation without harming the job market.
However, in an interview on Thursday evening, she noted that the oil price shock triggered by the Iran conflict will prolong the time needed for inflation to return to the Fed's 2% target and may lead the Fed to keep interest rates unchanged.
"Even before the oil price shock, we had work to do; with the oil price shock, that work will take longer," Daly said. Although oil prices retreated somewhat after the U.S. and Iran announced a ceasefire agreement earlier this week, providing some relief, "no one is really sure how long this trend will last."
So far this year, the Fed has kept the short-term interest rate target range unchanged at 3.50%–3.75% in two meetings. Daly and several other Fed officials previously believed that tariff-related inflation would likely ease later this year, allowing the central bank to resume interest rate cuts. She had previously suggested that one, or possibly two, rate cuts might be needed.
Subsequently, the Iran conflict erupted, causing oil prices to surge sharply and gasoline prices to rise above $4 per gallon.
Daly indicated that if the oil price shock persists, it "will push up inflation and slow economic growth. As policymakers, we must balance these risks and make optimal decisions to achieve our dual goals as smoothly and quickly as possible."
She stated that the risks to the Fed's dual objectives of maximum employment and price stability are currently balanced.
She outlined possible future scenarios:
"The first scenario: the conflict subsides quickly, the ceasefire holds, the situation is largely resolved, oil prices fall, and businesses and consumers see lower gasoline and other energy costs—we would then return to the previous track of solid economic growth, a stable labor market, and gradually declining inflation as tariff effects fade."
If these conditions materialize, she said, "then it's not impossible to continue advancing policy normalization through rate cuts."
However, she also focused on another scenario: even if the conflict ends, disruptions to oil shipping due to the war could keep inflation elevated longer than the Fed expects. "If that happens, we would certainly keep rates on hold until we are confident that the inflation target is within reach."
She noted that the likelihood of raising interest rates is lower than either cutting rates or holding them steady: "I believe the probability of a rate hike is much lower than the first two scenarios."
Daly emphasized that if the conflict persists and oil prices remain high, it would simultaneously boost inflation and slow growth, presenting complex trade-offs for the Fed.
"I do believe it's crucial to bring inflation back to 2%," she said, "but if achieving that comes at the cost of employment, it would place many families in a difficult position they shouldn't have to face."
Daly's interview came ahead of an upcoming government report widely expected to show that consumer prices last month recorded their largest increase in nearly four years.
"I think this impact is already evident in the economy; higher CPI data won't surprise anyone," Daly remarked. She noted that people are paying more for fuel, farmers are worried about soaring fertilizer prices, and travel and tourism are declining due to concerns about driving or flying costs.
"The new development is that the conflict appears to be stabilizing, shipping lanes may reopen, and people's lives could gradually return to a reasonable state," she said. "But there is still uncertainty about this."
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