WASHINGTON, March 26 (Reuters) - A price shock from higher oil prices could trigger rising inflation expectations that the U.S. Federal Reserve needs to guard against, Fed Governor Michael Barr said on Thursday, a further reason the Fed should take time to assess the economy before any further reduction in interest rates.
If the Iran conflict "continues for some time, the spike in energy prices and other commodities could have broader implications for both prices and economic activity," Barr said
in comments prepared for delivery at a Brookings Institution event.
"We have had five years now of inflation at elevated levels, and near-term inflation expectations have risen again, so I am particularly concerned that yet another price shock could increase longer-term inflation expectations."
That could in turn make overall inflation harder to control as firms and households set price and wage demands with higher inflation in mind, he said.
"We need to be especially vigilant," Barr said. "Given the considerable uncertainty about the potential effects of developments in the Middle East on our economy, as well as the other factors I mentioned, it makes sense to take some time to assess conditions," before loosening monetary policy further.
The Fed held its policy interest rate steady in the 3.5% to 3.75% range last week. The rise in oil prices has led investors to expect the Fed will not cut rates at all this year - and may even increase them if inflation intensifies. Policymakers say they still expect a single quarter-point reduction by the end of the year.
Inflation is currently about a percentage point above the Fed's 2% target, and has not changed much over the past year.
Barr, who was the Fed's vice chair for supervision before leaving that role at the start of President Donald Trump's second term, said he also felt that recent regulatory decisions and supervisory staff cuts had weakened the banking system's resilience.
The changes have been pressed by his replacement, Fed Vice Chair for Supervision Michelle Bowman, to dial back what she argues was overly restrictive regulation imposed since the 2007 to 2009 financial crisis.
"The safety and soundness of the banking system is built on trust, and I fear we are eroding that trust," Barr said.
(Reporting by Howard Schneider; Editing by Stephen Coates)
