Fed’s George Says Rate-Hike Debate Must Include Balance Sheet

(Bloomberg) -- Federal Reserve Bank of Kansas City President Esther George said raising interest rates by half a percentage point in May will be an option as the central bank confronts the hottest inflation in 40 years, though the size of the increase will need to be weighed alongside plans for shrinking the Fed's $8.9 trillion balance sheet.

“I think 50 basis points is going to be an option that we will have to consider, along with other things,” George said in a Bloomberg News interview with Michael McKee on Tuesday. “We have to be very deliberate and intentional as we remove this accommodation. I am very focused on thinking about how the balance sheet moves in conjunction with policy-rate increases.”

Markets see a better-than-even chance that the Federal Open Market Committee will raise its benchmark rate by a half point when it next meets May 3-4. Chair Jerome Powell has said he would favor a bigger move if necessary to bring price pressures under control.

George, regarded as one of the more hawkish Fed presidents during her decade-long tenure, in recent months has called for steady and deliberate, rather than aggressive, actions. She said in the interview the Fed might need to raise rates above neutral -- a level that's neither stimulative nor contractionary -- to bring inflation down to the Fed's 2% target. Central bank officials estimate neutral at about 2.4%.

“I think if you just look at where we are today, you might say we will have to go above neutral to bring inflation down,” George said. “But there is a long time between now and the end of the year to see how the economy unfolds.”

Meanwhile, shrinking holdings of mortgage-backed securities and Treasuries is likely to be done at a faster rate than in the previous downsizing -- 2017 to 2019 -- she said.

Businesses in the Kansais City Fed's region continue to grapple with supply-chain issues that have raised costs while retaining the ability to boost prices, George said. The Fed is monitoring the progress.

“We are watching carefully because we know from looking at consumer sentiment right now people hate high inflation and that has its own effects on the economy,” she said.

Policy makers in March voted 8-1 to lift their key rate to a target range of 0.25% to 0.5%, the first increase since 2018, after two years of holding borrowing costs near zero to insulate the economy from the pandemic.

In the Fed's so-called dot plot, officials' median projection was for the benchmark rate to end 2022 at about 1.9% -- in line with traders' bets but higher than previously anticipated -- and then rise to about 2.8% in 2023.