A senior Federal Reserve policymaker has batted aside investor concerns that US officials made an error in lifting interest rates against a backdrop of weak inflation, arguing the central bank should forge ahead with plans to reduce its balance sheet.
Patrick Harker, the president of the Federal Reserve Bank of Philadelphia, said he advocated policymakers "pause" on rates in the coming months while they started paring back the bank's asset holdings. But he stressed that his business contacts were being "really pressured" by demands for wage rises given the strong jobs market and that he expected inflation should eventually assert itself.
"We need to get on with this," Mr Harker said, referring to the Fed's plan to phase out reinvestments of the proceeds of maturing securities on its $4.5tn balance sheet. "We have been talking about it for a long time; it has been part of our plan. The economy is strong enough now where we can start to do what we have said we are going to do."
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Mr Harker's words come as the Fed and its chair Janet Yellen face down criticism from investors over last week's decision to lift rates by a quarter-point despite three successive months of soggy inflation data and recent tepid GDP growth.
Market-implied inflation expectations have drooped since the Fed meeting and some traders are betting the central bank will have to soft-pedal its tightening process.
The Philadelphia Fed president is a rate-setter on the Federal Open Market Committee this year. He has been at the hawkish end of the policy spectrum in arguing for rate rises. He acknowledged the central bank's policy forecasts were "a little more aggressive" than what the market had priced, stressing that "if in fact inflation is softening then I would revise my stance of policy".
There may "possibly" be one more rate increase this year according to Mr Harker's forecast, following on from the rises in March and June.
One scenario would see the Fed starting to phase out reinvestments before it went ahead with another rate rise, he suggested.
"It is prudent for us to pause on the next rate increase; at some point, and I would assume it is this year, cease reinvestment; and see how the markets react. We can take our time to do this. We don't have to be in a rush."
Mr Harker was speaking in his office following a tour of the Philadelphia Shipyard, which has been using an apprenticeship programme to bolster supply of skilled workers. The central banker said that there was "very little slack" left in the jobs market and that the so-called Phillips Curve, which relates low joblessness to inflation, would eventually kick in. "There is a rate [of unemployment] below which you are going to start to see a significant acceleration of wages," he said.
"You look at this labour market and you do have to question when we are going to start to see some increases in inflation," he said. "We know from history that when that happens it happens pretty quickly."
Mr Harker added that he was bearing in mind the lessons of the 2000s, when the Fed was accused of allowing the economy to overheat. "That is why I want to continue on this gradual path of removing accommodation — it is one of the reasons. Creating a soft landing is hard, but it is not impossible."
Stressing that policy was still supporting the economy in spite of four rate increases, Mr Harker said he wanted to see inflation hit the Fed's 2 per cent target or perhaps overshoot it a little. US inflation would follow the trend in the rest of the world, where growth was picking up. "It will also mean that prices, commodity prices and so forth, will naturally start to rise in that environment if that growth continues," he said.
While estimates were varied, phasing out the Fed's reinvestments might only remove 25 basis points of accommodation "over an extended period of time", he predicted.
Given that modest impact and the low-inflation environment, it made sense to start the balance sheet runoff before further rate increases. September's meeting was a possible moment to begin the process, Mr Harker suggested, but he emphasised that no decisions had been made.
"I wouldn't want to do it if we are starting to see further erosion of inflation and other negative economic data," he said. If Congress failed to lift its debt ceiling in a timely way, the Fed would also have to take this on board, he added. "What we know from previous episodes of debt ceiling crises is they are not helpful to the economy."
One of the reasons markets have grown more doubtful about the outlook for monetary tightening is the fading prospect of fiscal stimulus orchestrated by the White House.
Mr Harker said he was not factoring any economic boost from tax cuts into his forecast; this was in part because of the possibility that any growth benefits could be offset by higher trade barriers. There was also a risk that business confidence could be dented by a lack of policy progress in Washington.
"Some people I talk to are holding back and waiting to see what happens" on tax and trade policy before making investment decisions, he said. "We really do need that business investment and if they lose confidence that is not a good thing."