By Michael S. Derby
NEW YORK, July 9 (Reuters) – New York Federal Reserve President John Williams said on Thursday he did not expect a sustained rise in energy prices for the rest of the year despite the resumption of hostilities in the Middle East, and declined to say what decision he would make on interest rates at a policy meeting later this month.
“The markets still expect oil prices to come down over the next six to 12 months. I think that’s a pretty reasonable baseline,” Williams said at a conference at the regional Fed bank. “I still feel, kind of, the fundamentals are that energy prices are likely to be around their peak and then to come down over time.”
When asked whether the Fed could raise rates at its July 28-29 meeting, he said, “We haven’t even started the process of doing an analysis,” adding “we meet every six weeks. This isn’t like we’re making decisions forever.”
Williams spoke a day after the release of the minutes from the central bank’s June 16-17 meeting, at which the central bank held its benchmark interest rate steady in the 3.50%-3.75% range.
While forecasts released at the meeting last month indicated officials had penciled in higher rates this year amid persistently above-target inflation, Fed Chairman Kevin Warsh refused to provide guidance about the outlook and did not explain how incoming data might shape his monetary policy views.
In an interview with Fox Business Network’s “Mornings with Maria” program on Tuesday, Williams said he had grown more optimistic that overall high levels of inflation will ease in part due to falling energy prices tied to a seeming resolution of the Middle East war. He also reiterated that monetary policy is in the right position given the risks facing the economy.
But that outlook is now challenged by hostilities in the Middle East that again threaten to crimp the flow of energy and other goods. With President Donald Trump claiming the agreement that ended the hot phase of the conflict is now void, the risks of higher energy prices and inflation over the remainder of the year have risen, increasing the chances the Fed may have to raise interest rates to tamp down price pressures.
REACTION FUNCTION
On Thursday, Williams said it’s important for the U.S. central bank to explain how it reacts to data, given that there are a wide range of possible paths for price pressures. He said the minutes from the June meeting show the “richness” of the possible scenarios ahead.
“There are certain parts of the inflation outlook that are probably maybe a little bit more benign, say on the tariffs, maybe on the energy prices, depending how that plays out,” he said, adding that there are “other scenarios where inflation is more persistent and stays higher, which would … call for tighter monetary policy. I think that’s the right way to think about it.”
“I think that the minutes actually captured a collective reaction function in a way, even though it’s not designed to do that,” he said.
Williams reiterated the importance for the central bank to focus on incoming data. “I’ve spent much of my career as a policymaker talking about being data-dependent. I have not changed. I still think we need to be data-dependent.”
He also noted that investment tied to building the nation’s artificial intelligence infrastructure could bring lower price pressures in the future, but it was now clearly helping fuel inflation that he considers to be too high.
“If this creates a sustained impulse to demand relative to supply in the inflation … I do think that’s the kind of situation where you don’t look through this. You basically say you need to have a monetary policy positioned … to offset the inflationary impulse from that.”
BALANCE SHEET OVERHAUL
Williams weighed in as Warsh considers changes in the way the Fed manages its interest rate toolkit, with an eye toward further reducing the size of the central bank balance sheet.
Leading proposals are focused on allowing financial institutions to hold less emergency cash on hand, though many worry that could leave those firms more vulnerable to financial shocks and potentially more reliant on borrowing from the Fed when in trouble.
Some Fed officials have challenged the idea the balance sheet needs to be reduced, arguing the central bank’s management of short-term rates and market liquidity has been successful, and that the size of Fed holdings, now at around $6.7 trillion, is not a critical issue.
Any change should prioritize maintaining the safety and stability of the banking system, Williams said.
“I don’t think the driver of this should be” focused on the amount of Fed balance sheet reduction that can be achieved, he said. “It really should be how do we improve and make and strengthen our financial system.”
(Reporting by Michael S. Derby; Editing by Chizu Nomiyama and Paul Simao)