Fed's Paulson: If the economic situation is favorable, interest rates may be further reduced later this year.

Philadelphia Fed President Anna Paulson said that a slight further rate cut may be appropriate later in 2026, depending on whether the economic situation remains mild and favorable. Paulson said, "I see inflation cooling, the labor market stabilizing, and economic growth this year at around 2%. If all these conditions materialize, then some gentle further adjustments to the federal funds rate later this year might be appropriate." The Philadelphia Fed President pointed out that the labor market still faces some risks, as the slowdown in labor demand has exceeded the reduction in labor supply resulting from the Trump administration's tightening of immigration policies. However, she also mentioned that initial jobless claims seem to have stabilized, indicating that "the labor market is clearly bending but not breaking." Despite the Fed's rate cuts last month, Paulson estimated that the current monetary policy stance is still "slightly restrictive," which helps to continue downward pressure on inflation. She stated, "The overlay of past and current restrictive monetary policies will help completely pull inflation back to the Fed's 2% target level." Paulson acknowledged that the impact of tariffs on commodity prices may continue to push up inflation in the first half of 2026, but she expects commodity inflation to fall back to the 2% target level in the second half of the year. After three rate cuts totaling 75 basis points in the last year, Fed officials are still divided on how much further to cut rates this year. More officials are leaning towards keeping rates unchanged at least until more data on inflation and employment are available. For 2026 forecasts, policymakers gave a median expectation of a 25 basis point rate cut, while the market expects at least two rate cuts. Policymakers are facing a challenging economic outlook. In November last year, the U.S. unemployment rate rose to 4.6%, the highest in four years, while potential inflation improved. Meanwhile, economic growth data unexpectedly strong, showing the U.S. economy expanding at an annualized rate of 4.3% in the third quarter. However, Paulson said the government shutdown and its impact on data collection "make interpreting the economic conditions more complex." Her economic outlook - which she noted did not take into account the latest unemployment rate data - reflects a "cautiously optimistic view on inflation while hoping for a clearer understanding of what factors are driving economic growth upwards while employment is weakening." Paulson reiterated her previous view that artificial intelligence (AI) could lead to a significant surge in productivity. In this case, the Fed would not need to worry about higher economic growth leading to inflation. However, she added that policymakers will face difficulties in real-time determining whether growth is driven by productivity improvements. Paulson also presented a paper she co-authored, emphasizing the importance of central bank credibility in containing skyrocketing inflation. The paper stated, "The inflation experience of the past five years does not appear to have left a lasting impact on long-term inflation expectations."