The Fed may need to reevaluate interest rate policy in light of recent inflation trends, according to former Cleveland Fed President Loretta Mester.
Speaking about the latest Consumer Price Index (CPI) report, Mester noted that although the report met expectations, it revealed a worrying pause in the progress of inflation, which could affect the FED's future decisions.
“The unfortunate thing is that it shows that we have a pause in the progress that was made on inflation,” Mester said. “That is a concern for the Fed because inflation has made very little progress over the last four months.”
The September summary of economic forecasts (SEP) had called for one rate cut by year-end and four more rate cuts totaling 100 basis points in 2024. However, Mester believes that forecast may no longer be in line with the current economic environment. He calls for a “review” of the policy path for next year, citing continued economic momentum and inflationary pressures despite earlier signs of improvement.
Mester confirmed the possibility that inflation will run higher than previously anticipated, which may require a tighter policy stance. While the Fed's dual mandate includes maximizing employment, Mester argued that the risk to employment has diminished, allowing the Fed to focus more on combating inflation.
Mester also noted the role of base effects and projections for early 2025, predicting that inflation could ease in the first quarter due to favorable year-over-year comparisons. However, he warned that inflation has been on a bumpy path and may require a more restrictive policy stance than the Fed had anticipated in September.
“Reaching inflation targets will probably take a little bit longer and require more restrictive policy,” the former Fed member said.
While the Fed initially projected four rate cuts in 2025, Mester now expects that number to be reduced to two or three, in line with changing economic realities. Mester also noted that the Fed could cut rates in December but that it would be important to pause in January to reassess the situation.
“The December meeting provides an opportunity to assess progress made and set a tighter policy path for 2026,” he said, adding that Fed Chair Jerome Powell could use the upcoming press conference to clarify future strategies.
“The modal forecast is for inflation to continue to fall, but achieving that will likely require tighter interest rates than initially expected,” Mester said.
*This is not investment advice.
