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The Fed is gearing up for a longer-than-expected inflation fight

Two Federal Reserve officials suggested Friday morning that inflation could persist longer than thought after the central bank's most closely watched inflation gauge surged by the most in months.

Cleveland Fed President Loretta Mester and Fed Governor Philip Jefferson said they remain concerned about an inflation rate that remains well above the Fed's 2% year-over-year target.

Mester reiterated that while inflation has moderated, the overall level remains too high. She noted recent research from the Cleveland Fed and a discussion paper that have suggested inflation could be more persistent than currently anticipated.

“I see the risks to the inflation forecast as tilted to the upside and the costs of continued high inflation as being significant,” Mester said at the U.S. Monetary Policy Forum in New York. “So in my view, at this point, with the labor market still strong, the costs of undershooting on policy or prematurely loosening policy still outweigh the costs of overshooting.”

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The comments came as the Fed’s preferred measure of inflation – the personal consumption expenditures (PCE) index – unexpectedly accelerated in January, rising 5.4% last month on an annual basis. Excluding volatile food and energy prices, the inflation gage rose 4.7%, both marking pickups after several months of declines.

On a monthly basis, the PCE index rose 0.6% in January compared with December. Core prices also rose 0.6% in January from the prior month, compared with December’s 0.4% increase. The numbers Friday came a week after the government released the Consumer Price Index, which showed a similar pickup in the inflation rate.

Loretta J. Mester, president and CEO of the Federal Reserve Bank of Cleveland, looks on at Teton National Park where financial leaders from around the world gathered for the Jackson Hole Economic Symposium outside Jackson, Wyoming, U.S., August 26, 2022. REUTERS/Jim Urquhart
Loretta J. Mester, president and CEO of the Federal Reserve Bank of Cleveland, looks on at Teton National Park where financial leaders from around the world gathered for the Jackson Hole Economic Symposium outside Jackson, Wyoming, U.S., August 26, 2022. REUTERS/Jim Urquhart (Jim Urquhart / reuters)

The hot read on inflation hit markets on renewed rate hike fears, with the Dow Jones Industrial average tanking 336 points.

"By betting on a terminal rate above 5.35%, the market is effectively betting that the recent momentum in both growth and inflation will be sustained through the summer," Jefferies chief economist Aneta Markowska said.

Mester, who does not vote on monetary policy decisions this year, told Bloomberg in an interview Friday morning that the latest inflation reading shows the Fed needs to keep raising interest rates but stopped short of suggesting it required a 50-basis-point rate hike at the next policy meeting in March. Mester said last week she wanted to raise the benchmark policy rate by 50 basis points at the last policy meeting to try to get to the peak rate faster, though she also didn't want to surprise markets.

In a separate interview Friday morning with CNBC, Mester signaled her forecast in December to raise rates a bit above 5% hasn’t changed much.

Speaking at the same Monetary Policy Forum on Friday, Boston Fed President Susan Collins said inflation is still too high and that the Fed has more work to do.

“Inflation remains too high, and recent data …all reinforce my view that we have more work to do, to bring inflation down to the 2 percent target,” said Collins. “I anticipate further rate increases to reach a sufficiently restrictive level, then holding there for some, perhaps extended, time.”

Also speaking at the conference, Jefferson said a limited supply of workers for jobs needed, which has pushed up wages, suggests inflation may cool slowly.

“The ongoing imbalance between the supply and demand for labor, combined with the large share of labor costs in the services sector, suggests that high inflation may come down only slowly,” he said.

Jefferson also said the forces driving inflation now are different that past inflationary episodes and therefore economic models won’t be as helpful to policymakers. Jefferson said the current situation is different because the pandemic created unprecedented disruptions to global supply chains and is having a long-lasting impact on the labor participation rate.

“The inflationary forces impinging on the U.S. economy at present represent a complex mixture of temporary and more long-lasting elements that defy simple, parsimonious explanation,” he said.

Jefferson says he thinks the Fed is addressing the spike in inflation proactively, unlike in the 1970s and has more credibility now.

Here's what bond king Jeffrey Gundlach exclusively told Yahoo Finance Live on inflation, recessions and black swans.

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