By Howard Schneider
WASHINGTON, May 1 (Reuters) – The U.S.-backed war with Iran could change the inflation outlook enough to force the Federal Reserve into “potentially a series” of rate hikes to defend the central bank’s 2% inflation target, Minneapolis Fed president Neel Kashkari said in explaining his dissent at this week’s Fed meeting.
“With an extended closure of the Strait of Hormuz and potentially further damage to energy and commodity infrastructure in the Middle East…the price shock wave could be much larger than is currently expected,” Kashkari said in a statement released as the lid on Fed policy communications lifted after the end of the meeting on Wednesday. “We would likely have to follow through with a strong policy response…Federal funds rate increases, potentially a series of them, could be warranted even at the risk of further weakness to the labor market.”
Kashkari was among 4 dissents at this week’s Fed meeting, the most divided policy vote since 1992.
The statement approved on an 8-4 vote repeated existing language to indicate the “easing bias” Kashkari and two of his colleagues opposed. The fourth dissent was in favor of a rate cut.
Kashkari said he did not object to holding the policy rate of interest steady, but felt the risks to inflation stemming from the Iran war have reached the point at which the Fed should no longer be implying in its statement, as it has been, that the next change in interest rates would be to reduce them.
Closure of the Strait of Hormuz shipping channel and threats to infrastructure have pushed global oil well above $100 a barrel for several weeks, touching $126 just this week versus $70 at the start of the conflict.
While current language in the Fed’s policy statement “is not a commitment to make further cuts…it is widely interpreted…to indicate the committee’s expectation that the next adjustment to the federal funds rate would be a cut,” Kashkari said.
“Given recent economic developments and geopolitical developments and the high level of uncertainty,” he wrote, the Fed “should offer a policy outlook that signals that the next rate change could be either a cut or a hike.”
Kashkari said even a “benign scenario” where the Strait of Hormuz opens relatively soon to allow the flow of oil and other global commodities to resume, underlying inflation in the U.S. would remain at 3% for the year – well above the central bank’s 2% target and high enough in his view to leave the policy rate unchanged.
(Reporting by Howard Schneider; Editing by Chizu Nomiyama )
