Federal Reserve officials continued to signal on Friday that the U.S. central bank may need to raise interest rates in the future if ongoing conflicts in the Middle East cause persistently high inflation to climb further. This potential shift in monetary policy outlook has gained traction even with Federal Reserve Vice Chair for Supervision Michelle Bowman, who has been one of the most dovish policymakers within the central bank. Speaking at a conference in Iceland on Friday, Bowman stated that the conflict and its resulting energy shock could alter her view on the interest rate outlook. "At this time, it seems premature to assess the extent and duration of the economic impact from the Iran conflict," Bowman said. However, she added, "If supply disruptions persist into the second half of the year, we might begin to see more widespread effects on inflation." Should such a scenario unfold, Bowman indicated she would be more likely to "consider shifting my view on the balance of risks," hinting at the possibility of supporting rate hikes. Several of Bowman's colleagues share concerns that the current energy shock may be difficult to dismiss as a temporary factor, especially since inflation has remained above the Fed's 2% target for several years. This perspective has led these officials to be open to considering interest rate increases to bring price pressures back to target levels. Minneapolis Fed President Neel Kashkari stated, "I think it's too soon to conclude we need to raise rates right away, but this makes me more attentive to the risk of persistent inflation and the potential for inflation expectations to become unanchored." Kashkari was one of three dissenting policymakers who favored a more hawkish stance at last month's Fed meeting. Financial markets are currently pricing in the Fed's next move to be an increase from the current 3.50%-3.75% benchmark rate range, potentially before year-end. Prior to the supply chain disruptions and surging energy prices triggered by the U.S.-backed conflict involving Iran, Fed officials had been contemplating rate cuts. Philadelphia Fed President Anna Paulson, speaking to a business group in New Jersey on Friday, described the current monetary policy stance as "appropriate," given unacceptably high inflationary pressures and economic uncertainty. Paulson added that the Fed is prepared to "respond." While she believes U.S. monetary policy is in the right place, "I think it's healthy that market participants are pricing in scenarios where the federal funds rate stays higher for longer, and where further tightening may be necessary." However, as San Francisco Fed President Mary Daly noted in an interview, "There's no urgency to adjust" rates at present. "Policy is in a good place," she added—a phrase commonly used by Fed officials to signal comfort with the current policy rate—and stated that any future action would likely depend on when the Iran conflict truly concludes. Following reports of a U.S.-Iran agreement to extend a ceasefire by another 60 days, oil futures prices fell more than 2% on Friday and were on track for their largest weekly decline since early April. Worrisome Inflation Data Daly said that if crude futures prices "start moving higher because the conflict persists, that would change my view on the inflation outlook." She also noted she would monitor whether service industries begin raising prices, a concerning signal that inflation could become more entrenched. So far, she has seen little evidence of this outside of industries where fuel costs constitute a significant portion of overall expenses. Nevertheless, it is clear that near- to medium-term inflation risks facing the Fed are accumulating. Data released on Friday showed a New York Fed indicator designed to capture underlying inflation dynamics jumped to 4% in April from 3.5% in March. Prices for goods and services excluding housing accelerated on a month-over-month basis in April. Furthermore, data from the U.S. government released on Thursday showed the year-over-year increase in the Personal Consumption Expenditures price index rose to 3.8% in April from 3.5% in March. Kansas City Fed President Jeffrey Schmid, speaking at the same conference attended by Bowman, stated that his "primary concern is inflation, which is too high and has been above target for too long." He added that the textbook strategy of viewing energy shocks as having no lasting impact is not currently viable. Schmid also hinted at the possibility of utilizing the Fed's balance sheet to help restrain price pressures. "Policy is not very restrictive at the moment, and I think there's some discussion saying... we need to start thinking about what tools we can use to actually make policy more restrictive," depending on how the oil shock evolves. "Perhaps we would use the balance sheet again as another tool to... create some restrictiveness," Schmid said. His views on the balance sheet may contrast with those of Fed Chair Kevin Warsh, who has been skeptical of using the central bank's bond holdings to amplify the effects of its interest rate policy.
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