Boston Federal Reserve President Susan Collins indicated that the Fed may need to raise interest rates if inflationary pressures broaden in the coming months, though this is not currently her most likely outlook for the U.S. economy.
Regarding her view on inflation's trajectory, Collins stated in an interview on Wednesday that she expects the inflationary pressures stemming from the conflict in Iran to eventually subside, with the current shock obscuring signs that underlying inflation is still declining. "However, the probability of that happening has decreased, while some other scenarios are less optimistic and would certainly be accompanied by higher, more persistent inflation," she said, noting this could necessitate a rate hike.
Collins highlighted three factors she is monitoring that could help determine whether the Fed needs to tighten policy. She emphasized that the most important is households' and businesses' expectations for future inflation, which have risen to the upper end of their historical range. Collins added that she is also watching whether price pressures spread from the energy sector to other goods and services, as well as the extent to which tariffs continue to pass through the pricing chain. She noted that wages are not a significant source of inflation.
On factors requiring close attention, rising inflation automatically reduces the inflation-adjusted level of the Fed's policy rate, which could make policy less restrictive without any action from officials. When asked if the Fed might need to raise rates simply to prevent its policy setting from becoming more accommodative in real terms, Collins said this is "one of the factors to consider." She added that the inflation-adjusted, or "real," interest rate is a "factor that needs to be closely watched." However, she stressed that she examines overall financial conditions comprehensively, not just the Fed's benchmark short-term rate. She believes these borrowing conditions have supported the recent resilience of the U.S. economy.
Regarding the signals the Fed should send, Collins, who does not have a vote on the Fed's rate-setting committee this year, expressed support for removing language at last month's meeting that suggested the next policy move would be a rate cut. Three regional Fed bank presidents dissented from the committee's decision to retain what is known as an easing bias. "It is appropriate to communicate in a slightly less pre-committed way," she stated. Collins directly linked the issue of statement wording to the question of inflation expectations: she said the public will only expect the Fed to maintain low inflation over the long term if the central bank maintains credibility through its rate decisions and communication. "How we talk about policy, as well as the actual rate decisions, both play a role in influencing this expectation environment," she said.
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