Mohamed El-Erian: Fed Left with No Choice but to Raise Interest Rates

The inflation reading for June came at a 41-year high, and this leaves the Federal Reserve with no choice but to raise interest rates aggressively, opening the door to a possible 100 basis point increase this month, said Allianz Chief Economist Mohamed El-Erian.

In an article for the Financial Times, El-Erian indicated that the 9.1% jump in the CPI would further erode the credibility of the Federal reserve after policy makers were previously so insistent that higher prices were temporary.

“The Fed now has no choice but to respond aggressively,” wrote El-Erian. "They are expected to raise rates by 0.75 percentage points later this month and the board could consider a full percentage point increase."

It is worth noting that the Federal Reserve will meet on July 26-27, which had already raised rates by 25, 50 and 75 basis points in previous meetings this year, which means that a 100 basis point hike would signal further acceleration in stress.

But he noted that this sharp rise and the belated political reaction are increasing the risks of a recession, especially as economic activity is already slowing.

Mohamed El-Erian added that while inflation is set to decline in the coming months, the CPI report showed that price pressures continue to expand.

As such, especially if the Federal Reserve fails to standardize its actions quickly, it would be foolish to rule out the chance of a third wave of inflationary pressures that would interrupt and reverse the downward trend for the next three months.

As the higher inflation reading pushes the Fed to be more hawkish, the repercussions will reverberate across other world economies and uncertainty will remain.

The economist stressed that the hot June reading will add to the phenomenon of so-called “small fires everywhere”, especially in developing countries.

"There is no doubt that the latest inflation figures indicate turbulent waves in the future, especially for the most vulnerable groups in society in the United States and around the world," said Mohamed El-Erian.