Fed's Bullard: Even "dovish" policy assumptions require further rate increases

© Reuters. FILE PHOTO: St. Louis Fed President James Bullard speaks about the U.S. economy during an interview in New York February 26, 2015. REUTERS/Lucas Jackson/File Photo

By Howard Schneider

WASHINGTON (Reuters) - Even under a "generous" analysis of monetary policy the Federal Reserve needs to continue raising interest rates probably by at least another full percentage point, St. Louis Federal Reserve President James Bullard said, arguing that rate hikes so far "have had only limited effects on observed inflation."

Bullard said that despite aggressive actions by the Fed this year the current target policy rate of between 3.75% and 4% remains below the "sufficiently restrictive" level the Fed feels is needed to lower inflation to its 2% target.

In a graphic presented for discussion at an economic event in Louisville, Bullard showed that using even "dovish" assumptions, a basic monetary policy rule would require rates to rise to at least around 5%, while stricter assumptions would recommend rates above 7%.

That entire range could fall if inflation declines more rapidly than expected, Bullard said, noting that "market expectations are for declining inflation in 2023."

However "caution is warranted," he said, since the investors and Fed officials "have been predicting declining inflation just around the corner for the past 18 months."

A measure of "core" inflation watched closely by the Fed and used in Bullard's analysis was running at 5.1% as of September, twice the Fed's target, leaving Fed officials aligned in favor of further rate hikes even as they discuss the pace and final destination of their policy tightening cycle.

"While the policy rate has increased substantially this year, it has not yet reached a level that could be justified as sufficiently restrictive, according to this analysis, even with the generous assumptions,” Bullard said. “To attain a sufficiently restrictive level, the policy rate will need to be increased further.”

His prepared remarks did not include his preferred actions at the Fed's upcoming December meeting, at which officials are expected to raise interest rates by half a percentage point.

Bullard's recommended lower bound for a "restrictive" level of policy is in line with recent comments by his colleagues and also with financial markets the are currently pricing a peak federal funds rate of around 5% next year.