Federal Reserve

Fed's Loretta Mester: Economy still 'strong,' 'gradual' rate hikes likely

Loretta Mester, president of the Cleveland Federal Reserve.
David Orrell | CNBC

Economic fundamentals remain strong despite the recent tumult in financial markets that has led to rising expectations of a recession, Cleveland Fed President Loretta Mester said Friday.

Consequently, Mester said she expects the U.S. central bank to continue on a "gradual" pace of rate increases. Mester's remarks come as the U.S. economy grew just 0.7 percent in the fourth quarter, stock market averages have gone into correction and Wall Street forecasts have declined considerably for the year.

Nevertheless, Mester — one of the Federal Open Market Committee's more hawkish members — said she expects the U.S. to shake off the current problems.

"Solid labor market indicators, including strong payroll growth, and healthy growth in real disposable income suggest that underlying U.S. economic fundamentals remain sound," Mester said, according to prepared remarks she was to give to the Global Interdependence Center in Sarasota, Florida.

"I continue to monitor developments, but until I see further evidence to the contrary, my current expectation is that the U.S. economy will work through this episode of market turbulence and the soft patch of economic data to regain its footing for moderate growth, even as the energy and manufacturing sectors remain challenged," she added.

The FOMC in December enacted its first interest rate hike in nine years. At the time, members indicated the likelihood of four more rate hikes in 2016.

However, further declines in energy prices coupled with fears of a growth slowdown in China and declining equity prices have led market participants to conclude that tightening in monetary policy this year is unlikely.

Mester conceded that energy prices have fallen more than she or the committee expected. But she echoed statements from Fed Chair Janet Yellen and others that the trend will change eventually.

"Oil prices cannot continue to decline indefinitely, nor can the dollar continue to appreciate forever," she said. "At some point, both will regain some stability and the effect of previous changes on inflation will dissipate."

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Mester cited continued progress in the jobs market and consumer strength as important drivers for future growth.

While noting that she expects the FOMC to have a lively discussion at its March meeting over recent developments, she still believes the Fed will continue on its path toward policy normalization.

She said she believes "the appropriate policy path will involve gradual reductions over time in the extraordinary level of accommodation that was necessary to address the Great Recession."

Just before Mester spoke, the government reported that consumer prices excluding food and energy grew 0.3 percent in January, their biggest move in more than four years.