WASHINGTON (AP) – President Jerome Powell said Wednesday that he supports the traditional quarter-point increase in the Federal Reserve’s base short-term interest rate when the Fed meets later this month, instead of the larger increase some of his politicians have offered.
But Powell has opened the door for a bigger boost in the event that inflation, which has peaked in four decades, does not fall sharply this year, as the Fed expects.
“I’m willing to propose a four-point increase in interest rates to fight the acceleration of inflation that has gripped the economy in recent months,” Powell told the House Financial Services Financial Services Commission on the first of two days of half-yearly before Congress.
Most other Fed officials in recent weeks have backed such a modest rise, while several have said they support a half-point increase. or at least are open to such an increase. Higher Fed interest rates tend to lead to higher spending on consumer and business loans, including housing and car loans and credit cards.
“We expect inflation to peak and start declining this year,” Powell said. But he added: “As inflation rises … then we would be prepared to act more aggressively,” raising interest rates by more than a quarter of a point later this year.
The stock market rose in response to Powell’s support for the smaller increase. The S&P 500 jumped 1.7% in mid-day trading.
The chairman of the Fed warned that the economic consequences of the Russian invasion of Ukraine and the resulting US and European sanctions are “very uncertain” and say it is “too early to say” how they could influence the Fed’s policy.
Prior to Russia’s invasion, the Fed plans to make a “series” of interest rate hikes this year, Powell said, potentially in each of the Fed’s remaining seven meetings. For now, the Fed will “continue carefully along the lines of this plan.”
Economists predict that the Fed will implement five to seven increases by a quarter. This month’s increase will be the first since 2018. And it will mark the beginning of a delicate challenge for the Fed: it wants to raise interest rates enough to cut inflation, which is now at its peak in four decades, but not so fast as to stifle growth and hiring. Powell argues that with a low unemployment rate of 4% and solid consumer spending, the economy can withstand moderately higher borrowing costs.
The Fed’s interest rate is now fixed close to zero, where it has been since the pandemic struck in March 2020, and the Fed has responded by cutting interest rates to help the economy.
Powell acknowledged that consumer price hikes have jumped far above the Fed’s 2% target – inflation reached 7.5% in January compared to a year earlier – and that higher prices lasted longer than expected. He also promised to use the Fed’s tools to bring inflation back to its target.
“We understand that high inflation imposes significant difficulties, especially on those who are least able to cover the higher costs of basic things such as food, housing and transport,” he said.
However, he added that the central bank expects inflation to fall gradually this year as tangled supply chains unravel and consumers withdraw some of the cost.
Most economists agree that inflation is likely to fall from its current level, but will remain high. Rising prices are spreading beyond the items damaged by the pandemic – cars, electronics, furniture and other household goods – into broader cost categories, especially rental costs..
Goldman Sachs has raised its inflation forecast and now predicts that prices, according to the Fed’s preferred measure, will still rise at a relatively high annual rate of 3.7% by the end of the year. That’s well above the Fed’s latest own forecast, released in December, at 2.7 percent. When the central bank’s politicians meet in two weeks, they will update this forecast.
Powell said the Fed would also begin to cut its huge $ 9 trillion balance, which more than doubled during the pandemic when the Fed bought trillions of dollars in bonds to try to keep long-term interest rates. He said central bank politicians were likely to agree on a plan on how to shrink their bonds when they meet in two weeks, but declined to say when the plan could be implemented. The shrinking balance of the Fed leads to a further increase in the cost of long-term loans.
In public statements, central bank officials discuss whether to raise interest rates by half a percentage point this month – an aggressive move – although most backed the traditional quarter-point increase. Russia’s invasion of Ukraine made an increase of half a point even less likely.
The invasion of Ukraine has raised oil prices by about 18% to about $ 110 a barrel, which will make gas more expensive. Some economists predict that average gas prices could soon reach $ 4 a gallon, compared to the national average of $ 3.66 on Wednesday.
More expensive energy will lead to even higher inflation than it would otherwise be in the coming months, which will strengthen the arguments for raising Fed interest rates. But more expensive gas also deprives consumers of money to spend on other things. This, in turn, is likely to hold back consumer spending and potentially weaken the economy, a scenario that would normally discourage the Fed from raising interest rates.
Apart from its effect on inflation, the war may have only a limited impact on the US economy, analysts say, as long as it does not escalate significantly. Only about 0.5% of US trade is with Russia.
Powell warned that the war could lead to a shortage of goods such as neon gas and palladium, which are used to make semiconductors. The lack of computer chips last year slowed down the production of cars and electronics and contributed to high inflation.
But the Fed chairman also suggested that the overall effect of the war on the US economy could be limited as long as the conflict does not escalate significantly.
“Our financial institutions and our economy do not have much interaction with the Russian economy,” he said. “And it’s getting smaller and smaller in recent years.”