Larry Summers: Fed should impose 1 percent rate hike amid ‘serious inflation problem’

Ex-Treasury Secretary Larry Summers suggested the Federal Reserve should consider a full-percentage-point rate hike after August’s inflation report came in worse than expected on Tuesday.

The August Consumer Price Index showed an 8.3% spike for headline inflation and a 6.3% surge for core inflation, which excludes food and energy prices.

Both numbers came in higher than expected, stoking fears that inflation is persistent despite the Fed’s policy-tightening efforts to date.

“It has seemed self-evident to me for some time now that a 75 basis points move in September is appropriate,” Summers tweeted. “And, if I had to choose between 100 basis points in September and 50 basis points, I would choose a 100 basis points move to reinforce credibility.”

A basis point is 1/100th of a percentage point.

Investors are pricing in a 28% probability of a full-point hike as of Wednesday morning, according to CME Group data, up from a 0% probability just one day earlier. A three-quarter-percentage-point jump is still seen as most likely, with a 72% probability.

Summers expanded on his review in a Twitter thread, noting the August CPI report showed the US “has a serious inflation problem” that will require aggressive action to correct.

“Core inflation is higher this month than for the quarter, higher this quarter than last quarter, higher this half of the year than the previous one, and higher last year than the previous one,” Summers said.

“With core inflation running above 7 percent this month and likely, given rent behavior, to remain elevated, I fear it is unlikely that a peak Fed funds rate around 4 will be enough to restore 2 percent inflation,” he added.

The current Fed funds rate is 2.25% to 2.5%. In Summers’ view, the Fed will need to implement more sharp hikes beyond its September meeting next week.

A hike of a full percentage point, or 100 basis points, would be the largest of its kind since the Fed began using overnight interest rates to set monetary policy in the early 1990s, according to Bloomberg.

Analysts at Nomura also predicted that the Fed will hike interest rates by a full point, citing the “emergency of a wage-price spiral” and “increasingly unanchored inflation expectations.”

While many investors are calling for forceful Fed action to bring down inflation, others are warning that the central bank risks causing “deflation” by continuing to hike rates despite mounting fears of a recession.

Jeffrey Gundlach, the chief investment officer of DoubleLine Capital known as the “Bond King,” told CNBC that the economy would be better off if the Fed hiked by just a quarter percentage point. However, he predicted a three-quarter-point hike was the most likely outcome.

“In spite of the fact that the narrative today is exactly the opposite, the deflation risk is much higher today than it’s been for the past two years,” Gundlach told CNBC.

Meanwhile, Fed Chair Jerome Powell recently reiterated the bank’s hawkish stance, stating during a speech that officials wanted to avoid “prematurely loosening policy” and were “strongly committed to this project and we will keep at it until the job is done.”