MNI INTERVIEW: Fed Hikes Possible If Inflation Lingers- Adrian

Top central banks including the Federal Reserve might need to consider raising interest rates if inflation pressures linger and appear to be boosting longer-run price expectations, senior IMF official Tobias Adrian told MNI. 

“There's a more adverse scenario where inflation is more persistent and more pronounced, and central banks ultimately have to hike policy,” said Adrian, Financial Counselor and Director of the Fund’s Monetary and Capital Markets Department, in an interview at his office ahead of this week’s IMF Spring Meeting. 

“Fed Chair Powell talked about looking through for the moment. The way I will put it is that there's a lot of value in that option while they are waiting to see how the situation evolves, and then depending on whether inflation is expected to feed into core or into the expectations to take the policy action.”

Adrian, also a former New York Fed economist, said the key will be to monitor expectations to ensure they are not becoming unanchored because of elevated energy and food prices linked to the war and the closure of the Strait of Hormuz. 

“You do see a hump shape where in the short term there's more inflation being priced in, but over the medium term and long term, expectations are well-anchored,” said Adrian. (See MNI INTERVIEW: Fed Will Hold Pat, Inflation To Spike-Benigno)

READY TO ACT

The Fed should not shy away from possibly using its balance sheet to offset any big market disruptions that could emerge from tightening financial conditions related to the Middle East conflict, said Adrian. 

“If there's an acute liquidity crisis, central banks including the Federal Reserve would be expected to step in to provide liquidity, and that could take the form of collateralized lending, like through the repo facility or through outright purchases,” he said. (See MNI INTERVIEW: Long Fed Pause Looms On Iran Shock - Sahm)

“We don't really see dysfunction in markets, but we do recommend that central banks are operationally ready for lending of last resort and any other emergency actions. That is clearly aligned with the financial stability mandate of central banks. It would certainly apply to the Federal Reserve as well.”

ELEVATED RISKS

Risks to global financial stability remain elevated due to tighter credit conditions following the Iran war energy shock which could expose pressure points ranging from high debt levels to vulnerabilities in private credit, Adrian said. 

“Yields have gone up, spreads have gone up, equity markets have come down, but it’s somewhat contained for the moment. So markets are optimistic about the length and the depth of the war,” said Adrian, whose department has just released its yearly Global Financial Stability Report.  

Still, as the report warns, there is a chance that investors’ sanguine attitude towards the conflict could be misplaced. 

“There's a severe scenario where you may have a hit on real activity and inflation may be even more persistent. And this is where we worry about financial stability concerns,” Adrian said. 

The report warns that “markets have corrected in an orderly manner so far, but risks are asymmetric. The longer the conflict continues, the greater the risk that global financial conditions – which had been very accommodative before the war – could tighten further and more abruptly.”