Written by Michael S Derby and Ann Saffer

NEW YORK/SAN FRANCISCO (Reuters) – Federal policymakers may need to raise U.S. borrowing costs above the 5.1% peak they set just this week, and keep them there perhaps until 2024 to drive high inflation out of the economy, three of them indicated on Friday.

The hawkish messages, delivered in separate appearances by New York Fed President John Williams, San Francisco Fed President Mary Daley, and Cleveland Fed President Loretta Mester, underscore the US central bank’s determination to do what it takes to ease Price pressures that erode wages and pressure. household budgets, despite what analysts say a million or more jobs could be lost in the process.

It also stands in stark contrast to the expectations expressed in the financial markets. Traders on Friday took bets that the Fed’s policy rate would peak below 5% and the Fed would start cutting interest rates in the second half of 2023 to mitigate what the New York Fed’s internal modeling suggests will be an economic slowdown.

New York Federal Reserve Chairman Williams said he doesn’t expect a recession, but told Bloomberg TV that “we’ll have to do what’s necessary” to bring inflation back to the Fed’s 2% target, adding that the peak rate “could be higher than we’ve written.”

The Fed raised interest rates this year from nearly zero in March to a range of 4.25%-4.5% in the steepest round of rate hikes since the 1980s, the last time it battled a rapid rise in rates. The Fed’s preferred measure of inflation is currently 6%, three times its target of 2%.

Earlier this week, as policymakers introduced their latest rate hike, they also published forecasts indicating that almost all of them see the need to raise rates further, to at least a 5%-5.25% range, in the coming months.

This sentiment surprised investors who were encouraged earlier in the week by data showing a second month in a row of slowing inflation which some took as a sign that the Fed’s rate hikes were coming to an end.

On Friday, the general stock market index closed down nearly 2% for the week as the Fed’s more hawkish stance eased. Bond traders meanwhile seem pretty convinced that the Fed will indeed beat inflation.

Federal Reserve policymakers welcomed the recent slowdown in inflation, driven by easing supply chain problems and higher interest rates that are constraining the housing market.

But they also view the strong labor market as a source of persistent price pressure with concern.

American employers add hundreds of thousands of jobs each month and the unemployment rate is as low as 3.7%. Policymakers say workers are in short supply, especially after millions retired early in the pandemic, and wage growth is far beyond what the economy can sustain.

“I don’t quite know why markets are so bullish on inflation,” said Daly of the San Francisco Fed, adding that it may be because markets are pricing in an ideal scenario. She said central bankers were setting policy for what she described as still “upside” risks to the inflation outlook.

Central bankers have become increasingly vocal that lowering inflation will require a slowdown in the labor market and will not attempt to balance interest rate cuts until they are sure they have beaten inflation.

Over the past several rate hike cycles, the Fed has raised rates and kept them there for an average of 11 months before lowering them.

“I think 11 months is a starting point, which is a reasonable starting point. But I’m willing to do more if more is required,” Daly said, adding that exactly how long will depend on the data. She said her forecast for the rates was in line with the peak rate of 5.1% projected by the majority of her colleagues.

The Fed has indicated its rate hikes are “continued,” and Daly’s comments indicate that it sees interest rates remaining high in the first two months of 2024 — even as the Fed forecasts the unemployment rate will rise to 4.6%, an increase that analysts say could mean Loss of 1.5 million or more jobs.

As of last month, central bank economists viewed the risks of recession versus continued growth as roughly equal, minutes from the November Fed policy meeting show.

Meanwhile, the Federal Reserve Bank of New York said Thursday that its internal economic model sees a 0.3% decline in overall activity next year and steady growth in 2024, with a return to positive growth the following year.

Federal Reserve policymakers this week projected GDP growth of about half a percent next year.

While not in and of itself a recession, such slow growth means that an unexpected shock could easily lead to an outright contraction for a few quarters, Cleveland Fed’s Mester told Bloomberg.

It identified itself as one of seven of the Fed’s 19 federal policymakers who see rates needing to rise above the 5.1% average in the Fed’s forecast published this week.

In his press conference after the end of the December 13-14 policy meeting, Fed Chair Jerome Powell signaled the challenges that higher unemployment rates could pose, if not necessarily a recession.

“I wish there was a completely painless way to restore price stability,” he said. “No, and that’s the best we can do.”