Fed again hoping for a pain-free landing from current inflation spike

WASHINGTON/SAN FRANCISCO, Sept 24 (Reuters) - US Federal Reserve officials, who have begun hiking interest rates to tame high inflation, believe they can do so without damaging the job market if businesses come to anticipate falling inflation as a reason to raise prices less.

Success may hinge on what's driving prices higher, a matter of debate among policymakers, but comments by Fed Chairman Kevin Warsh last week and others since ‌then show central bank officials feel a soft, if slow, landing from inflation is attainable, requiring little if any rise in the unemployment rate.

"If people think the Fed is on the case in doing something about inflation, that ‌does tend to flow through to people's expectations in price-setting behaviors. Flip side, if they don't think we're on the case, I think it flows through to price-setting behaviors," Richmond Fed President Thomas Barkin said on Wednesday, channeling his McKinsey & Co consulting years to describe the fight within companies between raising prices and preserving ​market share. "You could reduce inflation physically: less demand, more supply, prices come down. You could reduce inflation based on expectations."

There exists a counterargument: Absent an abrupt end to the energy, tariff and other supply shocks currently stoking inflation, something needs to take a hit from rate hikes in order to slow inflation, whether it is consumers cutting back or businesses slowing investment.

Whether inflation stems from supply shocks or classic overheated growth, "the only way the central bank can close the gap is by reducing demand — and, with it, output and employment," Chicago Fed President Austan Goolsbee said earlier this week.

Now, however, Fed officials including Warsh appear to be banking on factors that would allow expectations rather than demand destruction to do their work. The labor market is seen as balanced near full employment, with the jobless rate of 4.1% and moderate wage ‌gains considered consistent with 2% inflation. Inflation, as measured by the Personal Consumption Expenditures Price ⁠Index, is high enough at 3.7% to concern central bank officials, but not near the post-COVID-19-pandemic levels that prompted the stiffest Fed rate hikes since the 1980s.

Inflation expectations are considered anchored around the 2% target, an asset the Fed is counting on heavily, and some easing of price pressures may be already in train if tariff and energy shocks ease as expected.