Fed's Kashkari says Iran war obscures monetary policy outlook

* Kashkari cites Iran conflict as new economic shock

* Fed's rate cut expectations affected by rising oil prices

* Kashkari unsure how war impact will weigh on Fed policy

By Michael S. Derby

NEW YORK, March 3 (Reuters) - Federal Reserve Bank of Minneapolis President Neel Kashkari said on Tuesday that the Iran conflict has increased uncertainty about the U.S. economic outlook and made it harder to know what lies ahead for central bank interest rate policy.

In terms of the outlook, "I had a lot of confidence up until a couple of days ago," before the joint U.S.-Israel attack on Iran started, Kashkari said at an event held by Bloomberg in New York.

The central banker, who has a voting role on the interest-rate-setting Federal Open Market Committee this year, said he came into 2026 with an expectation that waning inflation pressures would clear the way to a single interest rate cut. Now, when it comes to monetary policy, "we need to see with this new shock, potentially a new shock hitting the global economy...how long is the effect, and how big is the effect?" Kashkari said.

"The question I think that we are wrestling with, and markets are wrestling with, is, how long is this going to last? How bad is it going to get? Is it going to look more like Russia-Ukraine, or is it going to look more like Hamas attacking Israel, and that's going to have effects on monetary policy," Kashkari said.

He noted that the inflationary impacts of these kinds of conflicts can be unpredictable and that's why he'll need to see how the data comes in.

The Fed trimmed its overnight target rate range by three quarters of a percentage point last year to between 3.5% and 3.75% as it sought to support a softening job market while still working to lower high levels of inflation back to 2%.

While Fed officials had been relatively quiet about providing monetary policy guidance so far this year, financial markets had been expecting Fed rate cuts in 2026. Markets started to pare back those odds as oil prices rose and threatened what had been progress in lowering inflation. But rate-cut expectations could get new life if it becomes clear that the Trump administration's war could substantially weigh on economic activity.

Kashkari noted in his remarks that while the Fed generally tries to look at underlying inflation signals to divine the outlook for price pressures, that could be different in the current situation.

"If headline inflation is going to be elevated for an extended period of time, coming off of five years of elevated inflation, boy, that's a...scenario that we need to pay close attention to" and how it might affect inflation expectations, Kashkari said.

Ahead of the attack on Iran, the Fed bank president said he saw a fairly positive outlook for the economy. Inflation was likely to ease and the state of the job market was "pretty good" but softening, he said.

"I felt like policy was in a pretty good place and we have the luxury of just letting it gradually glide back to neutral," he said, noting the uncertainty of what now lies ahead.

Kashkari also said he's looking forward to a productive relationship with Kevin Warsh, named to be next Fed chair to succeed current leader Jerome Powell, whose term as chair ends in May.

He said he was open to engaging on the prospective Fed leader's criticism of the institution and his views about how to manage the Fed's large balance sheet and rate control management system.

Kashkari also said he'd "love it" if Powell decided to stay in his governor term after the chair term concludes. Powell can stay in that slot until 2028 and many believe he'll do so to help protect the central bank's independence amid attacks from the Trump administration.

(Reporting by Michael S. Derby; Editing by Andrea Ricci )