Inflation "is not a risk. It's there," Musalem said, noting that even after stripping out the impact of oil and other supply-related factors, underlying inflation is running perhaps a percentage point above the Fed's target and is "moving in the wrong direction."
Little progress has been made recently in the battle to bring inflation back down to the 2% target. The Personal Consumption Expenditures Price Index, the Fed's main inflation gauge, was at 3.7% on a year-over-year basis in July, compared to a recent low of 2.3% in April of 2025, as the Trump administration rolled out its plan for global import tariffs.
The shock to import prices was followed this year by the start of the US-Israeli war with Iran, which pushed up fuel costs globally, with the price of diesel hitting a record high recently. Prices for commodities like copper have also been rising, Musalem said, as an offshoot of the artificial intelligence investment boom.
Through it all, US domestic spending and growth have remained resilient — good news from one perspective, but an additional inflation challenge for the Fed.
"We have both strong demand forces and supply forces working themselves through the economy," Musalem said.
The Fed last raised interest rates by a quarter of a percentage point last week and dropped a reference in its policy statement that attributed recent inflation "in part" to supply shocks, saying only that "inflation remains elevated."
The change reflects growing skepticism at the central bank that current price pressures are likely to fade over time without Fed action. Though things like tariffs and oil price increases were seen as potentially fleeting, one-off changes in the price level, their influence has proved more persistent than expected, with inflation now being driven by demand aspects as well.
"I think there's a recognition that consumption and investment are growing at a very healthy, very strong clip, and at the same time the risks on the inflation side seem to have increased for a variety of reasons, including geopolitical forces," Musalem said.
The St. Louis Fed chief said he views the current 3.75%-4.00% policy rate as "on the accommodative side," meaning it is not yet high enough to restrict economic activity.
Investors currently expect the Fed to approve three more quarter-percentage-point rate hikes over the five policy meetings between now and April, with roughly even odds the central bank will hike again in October, on the eve of the US midterm elections. The median projection of Fed officials issued after last week's meeting showed policymakers anticipate one more hike this year, with a near-even split over the need for another such move in 2027, a less aggressive outcome than investors currently anticipate.
Though tighter policy may be needed, Musalem said he did not think it would need to come at the cost of higher unemployment, or that it would boost the likelihood of a recession.
"The labor market is not a source of inflation. There's not necessarily a need to slow the labor market down or to cool it to attain our inflation target," Musalem said, with the job market "stable and balanced and around full employment."
But he said he hoped businesses would scale back the pace of price increases that contacts in his Fed district say are on the horizon.
Firms are "reporting sharply higher non-labor input costs, in fuel and other raw materials, transportation, insurance, and skilled labor," Musalem said. "They're planning to raise their selling prices. ... There is ample evidence that inflation is the principal problem we have right now."
Musalem says more rate hikes likely needed
WASHINGTON, Sept 21 (Reuters) - The Federal Reserve will likely need to hike interest rates further to lower inflation resulting from strong demand as well as a commodity price shock that has moved beyond oil, St. Louis Fed President Alberto Musalem said on Monday, adding that it would be better for the US central bank to act sooner than wait.
"Both persistent demand and recurring supply forces are continuing to contribute to keeping inflation risks elevated, and I judge that without further policy restraint on inflation it is more likely to be substantially above our 2% target in 18 months than at target," Musalem said in an interview with Reuters.
"I think it's crucial that policy puts a meaningful restraint on inflation" so the Fed reaches its inflation target in about a year and a half, allowing time for tighter policy to impact the economy, he said.
Musalem, who is not currently a voting member of the central bank's rate-setting Federal Open Market Committee, would not comment on the Fed's possible next steps or the estimated level the policy rate may need to reach to lower inflation.
But "earlier and incremental policy firming is better and less disruptive than later and larger and potentially more abrupt policy action" further in the future, he said.
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