Investing.com -- St. Louis Federal Reserve President Alberto Musalem on Wednesday flagged the risk of inflation stalling above the Fed’s 2% target amid concerns that the inflationary impact of tariffs may not be entirely transitory.
"I would be wary of assuming that the impact of tariff increases on inflation will be entirely temporary, or that a full ’look-through’ strategy will necessarily be appropriate," Musalem said.
If fully implemented, the impact of a 10% increase in the effective U.S. tariff rate could "increase the PCE inflation rate by as much as 1.2 percentage points," he added.
While the direct price-level effects of the tariffs are expected to have only a "brief and limited impact on inflation," the St. Louis Fed president warned that the "indirect effects could have a more persistent impact on inflation."
The risk of the Fed putting rate hikes back on the table, however, may also emerge should the labor market remain resilient or tariffs-induced inflation becomes entrenched.
"If the labor market remains resilient and the second-round effects from tariffs become evident, or if medium- to longer-term inflation expectations begin to increase actual inflation or its persistence, then modestly restrictive policy will be appropriate for longer or a more restrictive policy may need to be considered," he added.
While the St. Louis Fed president believes that inflation will decline to 2% by 2027, he cautioned that the risks are "skewed toward some further cooling of the labor market and inflation remaining above 2% or possibly rising in the near term."