Powell: Economy’s growth could require more Fed hikes to fight inflation
“Although inflation has moved down from its peak — a welcome development — it remains too high.”
The Associated Press’ Christopher Rugaber
The continued strength of the US economy may necessitate further interest rate increases, according to Federal Reserve Chair Jerome Powell in a closely watched speech on Friday that also highlighted the uncertain nature of the economic outlook.
Powell noted that the economy has grown faster than expected and that consumers have continued to spend aggressively, both of which could keep inflationary pressures high. He reaffirmed the Fed’s determination to keep its benchmark rate raised until inflation falls below the 2% target.
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“We’re watching for signs that the economy isn’t cooling as expected,” Powell said. “We are prepared to raise rates further if necessary, and we intend to maintain policy at a restrictive level until we are confident that inflation is moving sustainably down toward our target.”
“Although inflation has declined from its peak, which is a welcome development, it remains excessive.”
Powell’s speech, delivered at the annual conference of central bankers in Jackson Hole, Wyoming, highlighted the economy’s uncertainties and the complexities of the Fed’s response to them. It was a stark contrast to his remarks here a year ago, when he warned that the Fed would continue its campaign of sharp rate hikes to cool soaring prices.
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“The chair still has his finger on the trigger for another rate hike, even if it’s a little less itchy than it was last year,” said Omair Sharif, chief economist at Inflation Insights.
Significantly higher loan rates, as a direct result of the Fed’s rate hikes, have made it more difficult for Americans to buy a home or a car, as well as for businesses to finance expansions. At the same time, rent, restaurant meals, and other services continue to rise in price. “Core” inflation, which excludes volatile food and energy prices, has remained high despite the Fed’s 11-hike streak beginning in March 2022.
Despite this, the economy has continued to grow. Hiring has remained healthy, surprising economists who predicted that the rate hike would result in widespread layoffs and a recession. Consumer spending continues to grow at a healthy clip. And the unemployment rate in the United States is exactly where it was when Powell spoke last year: 3.5%, just above a half-century low.
“He is still very concerned about how quickly the economy is growing because, all else being equal, that means we need higher interest rates just to be restrictive,” said Diane Swonk, chief economist at KPMG.
Powell did not mention the possibility of the Fed cutting interest rates in his speech. Many on Wall Street predicted rate cuts by early next year earlier this year. Most traders now expect no interest rate cuts until at least mid-2024.
Powell stated that policymakers at the Fed believe their key rate is high enough to restrain the economy and cool growth, hiring, and inflation. However, he admitted that it is difficult to predict how high borrowing costs must be in order to slow the economy, “and thus there is always uncertainty” about how effective the Fed’s policies are in reducing inflation.
Officials at the Fed “will proceed with caution as we consider whether to tighten further or, instead, to hold the policy rate constant and await further data,” he said.
Since Powell’s speech at the Jackson Hole conference last summer, the Fed has raised its benchmark rate to a 22-year high of 5.4%. Inflation has slowed from a peak of 9.1% in June 2022 to 3.2%, remaining above the Fed’s 2% target.
Powell acknowledged the drop in inflation, calling it “very good news.” Consumer prices, excluding volatile food and energy prices, have started to fall.
“But two months of good data,” he added, “are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal.”
When the Fed’s 18 policymakers last issued quarterly projections in June, they predicted another rate hike this year. That expectation may have shifted in light of the government’s recent inflation readings, which have been milder. When the officials meet again on September 19-20, they will update their interest rate projections.
Some Fed officials, including John Williams, president of the Federal Reserve Bank of New York and a key member of the interest-rate setting committee, have suggested that the central bank’s rate hikes may be coming to an end.
Many economists have delayed or reversed their earlier predictions of a US recession. Optimism about the Fed pulling off a difficult “soft landing” — reducing inflation to its target level without causing a steep recession — has grown.
Many financial market participants anticipate not only a soft landing, but also an acceleration of growth. These expectations have contributed to a rise in bond yields, particularly for the 10-year Treasury note, which has a significant influence on long-term mortgage rates. As a result, the average fixed rate on a 30-year mortgage has risen to 7.23%, the highest in 22 years. Auto loan and credit card rates have also risen, potentially weakening borrowing and consumer spending, which are the lifeblood of the economy.
Emily Roland, co-chief investment strategist at John Hancock Investment Management, is one of the analysts who believes the Fed will not achieve a soft landing.
“The lag effect of all of the Fed’s tightening — the most we’ve seen in decades — is likely to bite and tip the economy into a recession,” she said. “It’s just taking a little longer to get there.”
Similarly, Sonia Meskin, head of US macro at BNY Mellon Investment Management, believes the financial markets are “underestimating the chances of a harder, delayed landing.”
“Much of the tightening may still be in the works,” According to Meskin, the full impact of higher interest rates may not be felt until next year.
Some economists believe that much higher long-term bond market rates will reduce the need for further Fed hikes because they will help cool inflation pressures by slowing growth. Indeed, many economists believe the Fed’s rate hike in July will be its final.
Even if the Fed does not raise interest rates further, it may feel compelled to keep its benchmark rate elevated indefinitely in order to contain inflation. This would introduce a new threat: maintaining high interest rates indefinitely risks weakening the economy to the point of triggering a downturn. It could also put many banks in jeopardy by lowering the value of bonds they own, a dynamic that contributed to the failure of Silicon Valley Bank and two other large lenders last spring.
