Hawkish Fed officials want to defect? Kashkari: Banking crisis exacerbates US recession risk

Federal Reserve Bank of Minneapolis President Neel Kashkari has acknowledged that recent banking turmoil has indeed increased the risk of a U.S. recession, but it is too early to tell what that means for the economy and monetary policy.

Asked on Sunday whether such pressures would tip the US into recession, he said, "It would definitely bring us closer."

"What we don't know is the extent to which these banking pressures have led to a widespread credit crunch. Will that slow economic growth? That's something we're watching very, very closely," he added. "It's too early to make any predictions about the next interest rate meeting."

Mr. Kashkari was more circumspect than the three Fed officials who spoke on Friday at the Fed's next meeting on May 2-3. On Friday, three Fed officials, including Mr. Bostic, president of the Atlanta Fed, said inflation remained the top priority and further tightening might be needed.

Sunday's comments may reflect a shift by Mr. Kashkari, who in recent months has been an outspoken hawk in favor of raising interest rates to cool prices.

Last week, policymakers raised the base rate by 25 basis points to keep up the fight against high inflation, although the extent to which the economy will be hit following the second-largest bank failure in US history remains uncertain. The rate rise took the US base rate to its target range of 4.75% to 5%.

Fed officials did drop their previously firm pledge to raise interest rates in a softer tone, saying instead that some additional tightening "may be appropriate" to bring inflation back to the Fed's 2 per cent target.

In fact, before this month's bank failures and market turmoil, Kashkari had said that the Federal Reserve should raise interest rates to around 5.4 percent and then hold them there until inflation cools.

The median forecast, updated after a meeting of 18 Fed officials this month, showed interest rates would climb to 5.1 per cent by the end of the year, unchanged from their December forecast, implying a further 25 basis points this year, although seven officials expected rates to peak higher.

Mr. Kashkari noted that in the current turmoil in the banking sector, a contraction in bank lending could help provide some tightening policies that policymakers hope will reduce inflation, which could reduce the need for interest rate hikes. He said that while the banking system was sound and banks had strong capital positions and a lot of liquidity, it would take time for the current problems to be fully resolved.

"All the pressures will take longer to clear on their own. There are some worrying signs. The positive signs are that deposit outflows appear to have slowed. Smaller regional banks are regaining some confidence," he added.

But at the same time, he said, other banks' large holdings of Treasuries, which contributed to the collapse of SVB, and commercial real estate could be the problem. He said that if the turmoil in the banking sector of the past two weeks continues, it could also cause more pain to the economy.