Raghuram Rajan calls for Federal Reserve rate hike, says US economy 'not being held back'

Former Reserve Bank of India governor Raghuram Rajan has called for the US Federal Reserve to raise interest rates to contain accelerating inflation, arguing that financial conditions remain too loose and the American economy shows little sign of being constrained by borrowing costs.

“The Fed should be raising rates or should have raised rates already,” Rajan told Bloomberg Television’s Haslinda Amin in Jackson Hole, Wyoming, where he is attending the annual gathering of central bankers and senior policymakers. “I would be more hawkish than where the Fed is right now.”

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Markets expect the Fed to raise borrowing costs in December as inflation remains elevated, while a sharp rise in bond yields has also signalled that investors are assigning some probability to a rate hike as early as September.

The outlook has put greater focus on Fed chair Kevin Warsh's speech at the Jackson Hole conference on Friday. Warsh has so far refrained from offering forward guidance, leaving markets looking for clues about the direction of monetary policy and its implications for global financial markets.

Rajan said financial conditions in the US were not sufficiently tight to bring inflation under control.

“I do think that financial conditions are not restrictive at this point,” he said, pointing to “very strong” investment in data centres as a key driver of US growth. The US also has a “very strong fiscal deficit, which doesn’t look like it’s coming down anytime soon.”

American consumers, meanwhile, are drawing down their savings while continuing to spend, Rajan said.

“When you have all these things together, it would suggest an economy which is not being held back.”

Warsh has ‘right instincts’

Warsh's communication with markets has come under scrutiny since he took charge of the central bank. Following the July policy meeting, he gave investors little indication of his assessment of the economy and avoided providing forward guidance on interest rates.

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Investors interpreted his remarks as signalling a lack of resolve to bring inflation back to target, sending long-term bond yields to a two-decade high.

Rajan, however, said he viewed Warsh's approach differently.

“Warsh has the right instincts,” Rajan said, adding that the Fed chief has sought to make clear that “he is very much against inflation,” and wants to bring it down.

Investors would now be looking for evidence from Warsh's Jackson Hole speech “that he has a plan to do it; that he knows what he has to do, and he can communicate that very clearly.”

Rajan is co-leading one of five task forces established by Warsh. His group is examining the Fed's approach to balance-sheet policy.

Rupee holds up

Turning to India, Rajan said the rupee had proved more resilient than some had expected. The currency was trading at around 95.50 to the dollar, compared with nearly 97 in May, after the Reserve Bank of India undertook measures to attract dollars into the country.

“At this point, I don’t think the currency is that far out of whack,” Rajan said. “I don’t think it’s a panic situation.”

RBI governor Sanjay Malhotra said in a recent interview that the central bank expected at least $80 billion in foreign-currency inflows from its recent measures.