El-Erian Argues 50 Bps Rate Hike May Help Reverse Damage To Fed's 'Inflation-Fighting Credentials'

Allianz chief economic adviser and noted economist Mohamed El-Erian said the Federal Reserve should raise rates by 50 basis points instead of a quarter-point rise, taking into consideration risk management, credibility and continuing misalignment between market pricing and its forward policy guidance for this year.

In an opinion piece published on Bloomberg, El-Erian argues that while inflation will indeed continue to decline in the immediate future, its main drivers have been moving toward the service sector which has increased the risk of more embedded price pressures when the labor market remains solid.

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The economist also highlighted that the window for more orderly rate increases has been opened wider with global growth surprising on the upside. “Financial conditions have loosened significantly in recent months and, by some measures, are around levels that prevailed last March when the Fed initiated this hiking cycle,” he said.

Meanwhile, the case for a downshift in rate hikes is getting stronger by the day. Data released on Thursday showed U.S. economy grew by an estimated 2.9% in the last quarter of 2022 against economist expectations of 2.6% growth. Major U.S. indices recorded gains following the news. The SPDR S&P 500 ETF Trust SPY closed 1.1% higher while the Invesco QQQ Trust Series 1 QQQ gained 1.95%.

Credibility: One argument by El-Erian is that sticking to a 50 bps hike will help reduce the risk of having to increase rates later this year when the global economy has weakened. It may also help reverse some of the damage to the central bank’s inflation-fighting credentials and also allows for easier recovery in the event of such an error, he said.

Having already fallen behind twice in interpreting the current inflation phenomenon and responding to it, further clock mismanagement would be damaging to the Fed’s credibility and future policy effectiveness, El-Erian noted.

Last week, the economist had said he is among the small group of people who think the Federal Reserve should not downshift to 25 basis points and stick to a 50 bps rate hike in its upcoming policy.

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Photo by IMF on Flickr