WASHINGTON — Chairman Jerome Powell said Wednesday he supports a traditional quarter-point increase in the Federal Reserve’s benchmark short-term interest rate at the Fed’s meeting later this month, rather than a larger increase proposed by some of its decision makers.
But Powell opened the door for a bigger hike in case inflation, which has hit a four-decade high, does not come down materially this year, as the Fed expects.
“I am inclined to propose” a quarter-point rate hike to combat the accelerating inflation that has engulfed the economy in recent months, Powell told the House Financial Services Committee during the first of two semi-annual congressional testimony days.
Most other Fed officials have backed a similar modest hike in recent weeks, while a few have said they support a half-point hike or are at least open to such a hike. Higher Fed rates generally mean, in turn, higher borrowing costs for consumers and businesses, including for home and auto loans and credit cards.
“We expect inflation to peak and start to decline this year,” Powell said. But he added: “To the extent that inflation is rising…then we would be prepared to act more aggressively” by raising rates by more than a quarter 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% at midday.
The Fed Chairman warned that the economic consequences of Russia’s invasion of Ukraine and the resulting sanctions by the United States and Europe are “highly uncertain” and said “it is too early to tell” how they might affect Fed policies.
Prior to Russia’s invasion, the Fed planned to make “one round” of rate hikes this year, Powell said, potentially at each of the Fed’s remaining seven meetings. For now, the Fed “will proceed cautiously with this plan.”
Economists expect the Fed to implement hikes of five to seven quarter points this year. This month’s increase would be the first since 2018. And it would mark the start of a tricky challenge for the Fed: It wants to raise rates enough to bring down inflation, now at its highest level in four decades. but not fast enough to choke. growth and hiring. Powell is betting that with unemployment low at 4% and strong consumer spending, the economy can handle slightly higher borrowing costs.
The Fed rate is now close to zero, where it has been since the pandemic hit in March 2020 and the Fed responded by cutting interest rates to help support the economy.
Powell acknowledged that consumer price increases have far exceeded the Fed’s 2% target – inflation hit 7.5% in January from a year earlier – and that rising prices persisted longer than expected. He also pledged to use the tools of the Fed to bring inflation back to its target.
“We understand that high inflation imposes significant hardship, especially on those least able to afford the higher costs of essentials like food, shelter and transportation,” the president said. Fed.
Still, he added that the central bank expects inflation to gradually ease this year as tangled supply chains unravel and consumers cut spending a bit.
Most economists agree that inflation is likely to decline from its current level, but will nevertheless remain high. The price hike is spreading beyond items that have been disrupted by the pandemic — automobiles, electronics, furniture and other household items — into broader spending categories, particularly rental costs.
Goldman Sachs has raised its inflation forecast and now expects prices, the Fed’s preferred measure, to continue to rise at a relatively high 3.7% annual rate through the end of the year. That’s well above the Fed’s most recent projection, released in December, of 2.7%. When central bank policymakers meet in two weeks, they will update this projection.
Powell said the Fed would also start trimming its massive $9 trillion balance sheet, which more than doubled during the pandemic when the Fed bought trillions of dollars in bonds to try to hold down longer-term rates. He said central bank policymakers would likely agree on a plan to reduce its bond holdings when it meets in two weeks, but declined to say when the plan might be implemented. The reduction in the Fed’s balance sheet has the effect of further increasing long-term borrowing costs.
In public statements, central bank officials debated whether to raise rates this month by half a percentage point – an aggressive move – although most backed a traditional hike of a quarter point. Russia’s invasion of Ukraine made a half-point increase even less likely.
The invasion of Ukraine has pushed oil prices up about 18% to around $110 a barrel, which will make gas more expensive. Some economists have predicted average gasoline prices could soon hit $4 a gallon, up from a national average of $3.66 on Wednesday.
More expensive energy will send inflation even higher than it otherwise would have been in the coming months, which will strengthen the case for Fed rate hikes. But the more expensive gas also robs consumers of money to spend on other things. That, in turn, will likely dampen consumer spending and potentially weaken the economy – a scenario that would generally discourage the Fed from raising rates.
Besides 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 shortages of products such as neon gas and palladium, which are used to produce semiconductors. A lack of computer chips last year slowed 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 significant interactions with the Russian economy,” he said. “And it’s gotten smaller and smaller in recent years.”