Fed Plans to Keep Hiking Gradually as Risks From Trade War Mount

(Bloomberg) -- Federal Reserve officials said a “very strong” economy warranted continued increases in their benchmark policy rate while citing an escalating trade war and emerging-market turmoil as risks to growth.

“They are pretty confident in their baseline outlook” and will stick to their plan of continuing to raise interest rates, said Harm Bandholz, chief U.S. economist at UniCredit Bank AG. “Trade is the gorilla in the room and nobody knows how bad” the mounting dispute could be for businesses.

U.S. central bankers are trying to keep the economy on a sustainable path as growth gets a boost from tax cuts and additional government spending. Minutes of the Fed's June 12-13 meeting released Thursday showed officials committed to moving toward a slightly restrictive monetary policy, based on their outlook that low unemployment will lift wages and keep inflation near their 2 percent target over the medium term.

At the same time, they showed concern that trade wars could hurt business sentiment and investment, noting that industry contacts said that it was already having an impact.

“They have a lot of reasons to keep raising interest rates gradually,” said Laura Rosner, senior economist at Macropolicy Perspectives LLC in New York. “You get a sense, though, that they are preparing for surprises.”

The U.S. has imposed tariffs on imported steel and aluminum and threatened to slap more levies on other products from some of its biggest trading partners, particularly China and the European Union. All have vowed to retaliate in what would amount to a trade war that could raise prices and slow the global expansion. U.S. tariffs on $34 billion of Chinese goods are scheduled to go into force early Friday.

“Most participants noted that uncertainty and risks associated with trade policy had intensified,” the minutes said.

Nevertheless, with the economy strong and unemployment below their estimate of its long-run sustainable rate, officials judged “it would likely be appropriate to continue gradually raising the target range for the federal funds rate to a setting that was at or somewhat above their estimates of its longer-run level by 2019 or 2020,” the minutes showed.

At the June meeting, officials unanimously raised the main lending rate for the second time in 2018 -- to a target range of 1.75 percent to 2 percent -- and lifted their median projection to a total of four hikes this year, from three estimated in March. Fed officials also forecast that their campaign of gradual rate increases would move policy to a restrictive setting, or one that was slowing growth, by the end of 2019.

Reflecting that eventuality, the minutes said a “number” of officials said it might “soon be appropriate” to modify language in the Fed's post-meeting statement that currently describes rates as “accommodative.”

U.S. unemployment was 3.8 percent in May, matching the lows since the late 1960s, and the Fed's preferred gauge of consumer prices rose 2.3 percent on annual basis in May. Officials have said they will tolerate a slight overshoot to bolster inflation expectations after years of being under the target.

The minutes said U.S. central bankers debated the amount of labor-market slack left in the economy, with “several” participants saying “there was further scope for a strong labor market to continue to draw individuals into the workforce.”

Officials also discussed risks of inflation, with “a number” of them saying it was “premature to conclude that the committee had achieved” its 2 percent inflation target on a sustainable basis.

On the other hand, some officials voiced the concern that “a prolonged period in which the economy operated beyond potential could give rise to heightened inflationary pressures or to financial imbalances that could lead eventually to a significant economic downturn.”

--With assistance from Jeanna Smialek.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net

To contact the editors responsible for this story: Alister Bull at abull7@bloomberg.net, Brendan Murray

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