MNI INTERVIEW: Fed Will Hold Pat, Inflation To Spike-Benigno

Federal Reserve officials are likely to keep rates on hold for the foreseeable future as the Iran war appears set to boost inflation to uncomfortably high levels in coming months, former New York Fed economist Gianluca Benigno told MNI. 

“The sensible approach for the central bank is to wait and see,” Benigno said in an interview. “My feeling is that real-time indicators, monitoring the supply chain, you'll see soon these things are going to probably affect the prices.”

Benigno, who helped launch an index of global supply chain stresses during his time at the Fed, said the shock from Iran extends well beyond energy and has started to affect infrastructure that could a long time to get back online. 

“There are already, even if the situation goes back to normal, disruptions that are going to last far beyond the reopening of the Strait – and we’re not even in that situation,” he said. 

“That is what makes me think that this time we might see inflationary pressure building in, not immediately, but we should see first at the level of producer inflation and then propagating in the economy.”

While it’s difficult to conduct scenario analysis under such high uncertainty, one plausible prospect is for “a relatively big shock even for one month” to send PPI above 6% and CPI to around 4% by the first half of next year, he said.

That’s not to say that growth is not also at risk from the Iran shock, though Benigno is not worried about a recession on the horizon and believes the inflation threat is more prominent for the Fed. “I see more risk on the inflation side,” he said. 

Fed officials have recently indicated they are in no rush to lower rates further until they gain clarity about how any new shocks will affect the outlook. (See MNI INTERVIEW: Prolonged Fed Hold On Stagflation Risk-Lavorgna)

BALANCE UNDER WARSH

Benigno, now a professor of economics at the University of Lausanne, said Fed chair nominee Kevin Warsh is also likely to keep rates on hold when he takes over from Jerome Powell later in the year given renewed price pressures. 

But he also sees any rate hikes as a low probability. “I don’t see that happening, even though there are some FOMC participants that have that inclination.”

Just as it would be difficult for Warsh to push for a cut against the committee’s wishes, so would it be a tall order for hawks to make the case for actively hiking into an energy shock, said Benigno. 

“There is always a bit of mediation among different positions,” he said. 

The different responses from the Fed, which has signaled a prolonged hold, and the ECB, which is flirting with possible hikes, are explained in part by the different geographic hit from the energy supply disruptions, he said. 

Benigno believes the first line of defense against a prolonged energy shock should be some amount of fiscal support that shields consumers from the worst effects of the crisis, like some measures already being implemented in Asia.