Federal Reserve's policy rate will need to top 5%, St. Louis Fed head says

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St. Louis Fed President James Bullard has penciled in a federal funds rate range of 5.25%-5.50% at the end of 2023, "slightly higher than the median dot," he said in an interview with The Wall Street Journal on Wednesday.

"Although I would caution everyone that these kinds of things are a guess," as Fed officials don't know where the economy or inflation will be a year from now, he said.

After raising the federal funds rate target range by 425 basis points in 2023 to 4.25%-4.50%, Bullard said he's not ready to pause yet as the Fed still isn't sufficiently into restrictive territory.

"Inflation will probably recede during in 2023 but not as fast as projected to by the financial markets," Bullard said. "They (the markets) have inflation crashing in 2023... the history of core PCE (personal consumption expenditure) inflation is that it probably doesn't fall that fast. And so we'll probably still have some inflation at the end of the year."

The markets are pricing in a 25-bp rate hike for the Fed's Jan. 31-Feb. 1 meeting, bringing the rate to 4.50%-4.75%, with a 94.3% probability, according to the CME FedWatch Tool. Another 25-bp increase is priced in for the March meeting.

"We're almost into a zone that you could call restrictive. We're not quite there yet," he said. The Fed will have to get above 5% "to say with a straight face that we've got the right level of the policy rate that will continue to push inflation down during 2023."

The central bank shouldn't waver in its quest to squelch inflation, he said, pointing to lessons from the 1970s when policy was loosened too early and led to more inflation.

"I think that policy has to stay on the tighter side during 2023 as we're watching this disinflationary process unfold," Bullard said.

"If you look at core PCE inflation measured on a 12-month basis or the Dallas trimmed mean inflation, yes, it's down slightly... I'm very hopeful," but there are still some inflationary factors at play, he said.

For global inflationary dynamics, the European market doesn't look like it's heading for a recession and the reopening of China from COVID lockdowns are adding to inflationary pressures. "That's a risk we have to factor in when making monetary policy," he said.

Last week, Richmond Fed President Tom Barkin said the central bank still has more work to do to tame inflation.