Bank of America believes the Federal Reserve may still need to raise interest rates because underlying inflation remains significantly above its target.
In a note to clients on Friday, the bank challenged the argument that recent inflationary pressure mainly reflects temporary or one-off factors.
Bank of America Sees Persistent Inflation Risk
Bank of America analyst Aditya Bhave said the firm’s calculations show that underlying inflation remains well above the Federal Reserve’s 2% target.
This view suggests that recent price pressures may be more persistent than some investors expect.
Although certain inflation categories have weakened, the bank does not believe the broader trend provides enough evidence that price stability has been restored.
Fed Could Still Have Reasons to Raise Rates
The report also addressed speculation that Fed Chair Warsh could use recently established task forces as justification for delaying further monetary tightening.
However, Bank of America argued that he may have strategic reasons to raise rates sooner rather than later.
An early rate increase could strengthen his inflation-fighting credibility without making him appear fully responsible for the existing price problem, according to the bank.
The firm found no indication that the task forces would prevent the Federal Reserve from tightening policy if inflation remained elevated.
Markets Already Expect Some Rate Hikes
Financial markets are already pricing in nearly 40 basis points of additional interest rate increases.
However, Bhave argued that this may not be enough to create a meaningful tightening in financial conditions.
According to Bank of America, the Federal Reserve may need to deliver at least 75 basis points of rate increases to have a significant impact on borrowing costs, asset prices and economic activity.
This would represent a more aggressive policy response than markets currently expect.
Softer CPI Reduces Pressure for a July Hike
The latest US Consumer Price Index report was weaker than expected.
Headline inflation fell by 0.4% month over month in June. Core inflation also declined, marking only the seventh monthly drop since 1985.
Following the report, Bank of America lowered its estimate for monthly core Personal Consumption Expenditures inflation to 0.15%.
Despite the softer monthly reading, the bank expects annual core PCE inflation to remain at approximately 3.3%.
That level would still be considerably above the Federal Reserve’s official inflation target.
July Rate Increase Becomes Less Likely
Bank of America said the weaker inflation figures reduce the immediate pressure on the Federal Reserve to raise interest rates in July.
However, the bank stressed that one softer report does not eliminate the broader inflation risk.
Policymakers may therefore delay a rate increase without abandoning the possibility of tightening later in the year.
Future decisions will depend heavily on upcoming inflation, employment and consumer-spending data.
Retail Sales Show Mixed Consumer Demand
US retail sales for June were broadly in line with market expectations, although they came in below Bank of America’s own forecast.
Online and other nonstore retailers were an important source of strength during the month.
The figures suggest that consumer demand remains active, but growth is uneven across different areas of the economy.
Continued household spending could support economic growth while also making it more difficult for inflation to return quickly to the Fed’s target.
Warsh Maintains Focus on Price Stability
Bank of America also reviewed Warsh’s recent testimony and concluded that it did not introduce any significant change in policy direction.
He remained focused on restoring price stability while expressing optimism about stronger productivity growth.
Higher productivity could allow the economy to expand more rapidly without generating as much inflation. However, the bank found nothing in his comments suggesting that the newly created task forces would delay necessary policy tightening.
Fed Rate Hike Risk Remains
The latest inflation data may have reduced the probability of an immediate July rate increase, but Bank of America believes the case for higher rates remains credible.
Underlying inflation is still above target, consumer demand has not collapsed and current market pricing may not be sufficient to tighten financial conditions meaningfully.
As a result, investors may be underestimating the possibility that the Federal Reserve will raise rates again if inflation proves more persistent than expected.
