When the Federal Reserve meets later this month, Chair Jerome Powell said Wednesday that he supports a conventional quarter-point hike in the benchmark short-term interest rate, rather than a greater increase that some policymakers have requested.
Powell did, however, leave the door open to a larger raise if inflation, which has reached a four-decade high, does not fall considerably this year, as the Fed forecasts.
Powell told the House Financial Services Committee on the first of two days of semiannual testimony to Congress that he is “inclined to advocate” a quarter-point rate rise to combat the acceleration of inflation that has gripped the economy in recent months.
Most other Fed officials have recently expressed support for a similar moderate increase, while a few have stated that they support or are at least open to a half-point rise. Higher Fed rates usually mean higher borrowing costs for households and businesses, such as for home and vehicle loans, as well as credit cards.
“We have an expectation that inflation will peak and begin to come down this year,” Powell said. But he added: “To the extent inflation comes in higher … then we would be prepared to move more aggressively” Later this year, the Fed will raise rates by more than a quarter point.
Powell’s support for the lesser increase boosted the stock market. In mid-day trading, the S&P 500 gained 1.7 percent.
The Fed chair warned that the economic repercussions of Russia’s invasion of Ukraine, as well as the US and European sanctions that followed, are “very unpredictable,” and that “it’s too early to say” how they would affect the Fed’s policies.
Prior to Russia’s incursion, Powell stated that the Fed aimed to raise rates “a series” of times this year, maybe at each of the next seven Fed meetings. For the time being, the Fed will “move cautiously along those lines.”
Economists predict that the Fed will raise interest rates by five to seven quarter points this year. The rise this month would be the first since 2018. It would also signal the start of a tricky struggle for the Fed: It aims to raise rates just enough to bring down inflation, which is at a four-decade high, but not rapidly enough to stifle growth and hiring. Powell believes that the economy can survive somewhat increased borrowing costs because the unemployment rate is low, at 4%, and consumer spending is strong.
The Fed’s rate is presently approaching zero, where it has been since the epidemic hit in March 2020, prompting the Fed to lower interest rates to aid the economy.
Powell recognised that consumer price hikes have soared far above the Federal Reserve’s aim of 2% — inflation touched 7.5 percent in January compared to a year ago — and that higher prices have lasted longer than projected. He also promised to use the Fed’s instruments to return inflation to its target level.
“We understand that high inflation imposes significant hardship, especially on those least able to meet the higher costs of essentials like food, housing, and transportation,” the Fed chair said.
Nonetheless, he said that the central bank expects inflation to moderate this year as convoluted supply chains untangle and consumers rein in their spending.
The majority of economists say that inflation will likely drop from its current level, but that it will remain high. Prices are rising across the board, including vehicles, gadgets, furniture, and other household goods, as well as broader areas of spending, including rental rates.
Goldman Sachs has revised its inflation prediction, now predicting that prices would continue to rise at a relatively high annual rate of 3.7 percent by the end of the year, according to the Fed’s preferred metric. This is much higher than the Fed’s most recent forecast of 2.7 percent, which was released in December. That prediction will be updated when the central bank’s policymakers meet in two weeks.
Powell also stated that the Fed will begin to reduce its massive $9 trillion balance sheet, which more than doubled during the recession when the Fed purchased trillions of dollars in Treasuries in an attempt to keep longer-term rates low. He predicted that when the central bank’s officials meet in two weeks, they will likely agree on a plan to reduce the central bank’s bond holdings, but he declined to indicate when the plan would be executed. The Fed’s balance sheet shrinking has the impact of raising longer-term borrowing costs even more.
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Central bank officials have been debating whether to hike rates by a half-percentage point this month — an aggressive move — in public pronouncements, while most have backed a typical quarter-point increase. The invasion of Ukraine by Russia has made a half-point increase all the more unlikely.
Oil prices have risen by nearly 18% to around $110 per barrel as a result of the invasion of Ukraine, making gas more expensive. Some economists predict that national average gas prices will soon surpass $4 per gallon, up from $3.66 on Wednesday.
Inflation will rise considerably faster than it would have otherwise in the coming months as a result of increasing oil prices, reinforcing the argument for Fed rate rises. However, higher petrol prices deprive customers of money to spend on other items. As a result, consumer spending would likely be restrained, potentially weakening the economy – a circumstance that would normally dissuade the Fed from hiking rates.
Apart from inflationary effects, many believe the war will have a limited impact on the US economy if it does not escalate dramatically. Russia accounts for little about 0.5 percent of US trade.
Powell warned that the war could result in a shortage of semiconductor-making materials such as neon gas and palladium. Last year, a shortage of computer chips hampered vehicle and electronics production, contributing to soaring inflation.
However, as long as the conflict does not grow dramatically, the Fed chair believes the war’s overall impact on the US economy will be limited.
“Our financial institutions and our economy do not have large interactions with the Russian economy,” he said. “And it’s gotten smaller and smaller in recent years.”
