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(Bloomberg) — Federal Reserve Bank of St. Louis President Alberto Musalem said that while he anticipates price growth to moderate toward the central bank’s 2% goal, it is vital for policymakers to keep inflation expectations in check.

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Long-run inflation expectations have so far remained broadly stable, said Musalem, but he noted that he will be closely watching for any signs of expectations becoming unanchored. He reiterated that policy should stay “modestly restrictive” until there is more evidence inflation is headed toward the Fed’s 2% target. 

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“In determining how monetary policy should respond to alternative scenarios, especially when they might involve difficult employment and inflation trade-offs, it will be important that medium- to longer-term inflation expectations remain well anchored,” Musalem said in remarks prepared for a conference hosted by the National Association for Business Economics in Washington.

The St. Louis Fed chief emphasized his baseline expectation is for inflation to continue to decline and for the labor market to stay near full employment, an outcome he says “critically” requires inflation expectations remaining well anchored. He sees this scenario as likely if the “net effects” of new policies on trade, immigration, regulation and other fiscal changes are minor. 

It’s also possible, he said, the new government policies could help inflation fall more quickly while keeping the labor market stable. 

Stagflation Concerns

Data released Friday showed US consumers cut back on spending in January amid harsh winter weather, as the Fed’s preferred measure of underlying inflation showed some reprieve. Excluding food and energy, the gauge was up 2.6% from a year ago, matching the smallest annual increase since early 2021.

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The drop in consumer spending, combined with data showing Americans are growing more pessimistic about the outlook and are increasingly concerned about rising prices, is stoking fears the US economy could be heading toward a period of stagflation.

Musalem acknowledged it’s possible the central bank could confront a situation in which inflation “stalls above 2%” while the labor market weakens. 

“A deterioration of the labor market alongside higher inflation could present difficult choices,” Musalem said. “With inflation already above 2% and a full-employment labor market, the stakes are potentially higher than they would be if inflation were at or below target, and if consumers and businesses had not recently experienced high inflation, perhaps raising their sensitivity to it.” 

Musalem said he would be “especially concerned if I saw evidence suggesting inflation expectations were becoming unanchored today.”

Fed officials left interest rates steady in January after lowering borrowing costs by a full percentage point at the end of last year. Policymakers say they want to see more evidence inflation is on track to reach their 2% target and learn more about how President Donald Trump’s policies affect the economy. 

An update on the labor market is due Friday. The Fed’s next policy meeting will take place March 18-19. 

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