St. Louis Fed's Musalem says tariffs could trigger more persistent inflation

By Howard Schneider

(Reuters) - Risks have increased that U.S. inflation will stall above the Federal Reserve's 2% target or even rise further in the near term, with rising import taxes potentially triggering more persistent price pressures, St. Louis Fed president Alberto Musalem said on Wednesday.

Musalem said that while the initial direct effect of import taxes, also known as tariffs, could be short-lived, he was "wary" to think it would all fade away without influencing underlying inflation in a way that could force the Fed to react.

If it pushes inflation expectations and prices higher in a consistent way, Musalem said, it may even require the Fed to consider tighter monetary policy down the road, though that is not his baseline outlook.

"If the economy remains strong and inflation remains above our target, then I believe the current, modestly restrictive policy will remain appropriate until there is confidence inflation is converging to 2%," Musalem said in comments prepared for delivery to business groups in Paducah, Kentucky.

"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."

The Fed has generally shied from discussion of further rate hikes at this point, with a core outlook for inflation to slowly fall and the Fed eventually able to lower its benchmark rate from the current 4.25% to 4.5% range. In projections last week the median projection was for two quarter percentage point rate cuts this year.

But the Fed is also wrestling with how to assess the impact of Trump administration tariff plans that promise to intensify with new rounds of levies on autos and a broad set of nations expected in coming days.

Musalem said he agreed that some of the tariff impact may be felt through one-time price adjustments, but "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."

He said his staff estimated that tariff plans announced to date could raise the Fed's targeted inflation rate an extra 1.2 percentage points, with more than half of that due to second-round impacts that could prove more persistent.

(Reporting by Howard Schneider; Editing by Andrea Ricci)