Federal Reserve Chair Jerome Powell testifies to Congress in February 2020. Federal Reserve photo
Chair Jerome Powell said Wednesday that he supports a traditional quarter-point increase in the Federal Reserve’s benchmark short-term interest rate when the Fed meets later this month, rather than a larger increase that some of its policymakers have proposed.
But Powell did open the door to a bigger hike in the event that inflation, which has reached a four-decade high, doesn’t noticeably decline this year, as the Fed expects it to.
“I’m inclined to propose and support” a quarter-point rate hike to fight the acceleration of inflation that has engulfed the economy in recent months, Powell told the House Financial Services Committee on the first of two days of semiannual testimony to Congress.
Most other Fed officials have in recent weeks supported a similar modest rise, while a few have said they back a half-point hike or are at least open to such an increase. Higher Fed rates typically lead, in turn, to higher borrowing costs for consumers and businesses, including for homes and auto loans and 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” by raising rates by more than a quarter point later this year.
The stock market rose in response to Powell’s support of the smaller increase. The S&P 500 jumped 1.7 percent in mid-day trading.
The Fed chair cautioned that the economic consequences of Russia’s invasion of Ukraine, and the resulting sanctions by the U.S. and Europe, are “highly uncertain” and said “it’s too soon to say” how they might affect the Fed’s policies.
Before Russia’s invasion, the Fed planned to carry out “a series” of rate increases this year, Powell said, potentially at each of the remaining seven Fed meetings. For now, the Fed will “proceed carefully along the lines of that plan.”
Economists have forecast that the Fed will implement five to seven quarter-point hikes this year.
Powell spoke a day after President Joe Biden said in his State of the Union address that “my top priority is getting prices under control.”
This month’s increase would be the first since 2018. And it would mark the beginning of a delicate challenge for the Fed: It wants to increase rates enough to reduce inflation, now at a four-decade high, but not so fast as to choke off growth and hiring. Powell is betting that with the unemployment rate low, at 4 percent, and consumer spending solid, the economy can withstand modestly higher borrowing costs.
The Fed chair added that the central bank expects inflation to gradually decline this year as tangled supply chains unravel and consumers pull back a bit on spending. Many economists agree with him but nevertheless think inflation will stay elevated. Rising prices are spreading beyond items that were disrupted by the pandemic – autos, electronics, furniture and other household goods – into broader categories of spending, especially rental costs.
Goldman Sachs has raised its forecast for inflation and now predicts that prices, according to the Fed’s preferred measure, will still be rising at a relatively high annual rate of 3.7 percent by year’s end. That is far above the Fed’s own most recent projection, issued in December, of 2.7 percent.
Powell said the Fed will also begin reducing its huge $9 trillion balance sheet, which more than doubled during the pandemic when the Fed bought trillions of dollars of bonds to try to hold down longer-term rates. He said the central bank’s policymakers will likely agree on a plan for how to shrink its bond holdings when it meets in two weeks but declined to say when the plan might be implemented.
Oxford Economics, a consulting firm, projects that the Fed will reduce its holdings by about $400 billion this year, which it estimates would have the effect of rates hikes adding up to roughly one-half of a percentage point.
The invasion of Ukraine has driven up oil prices by about 18 percent to roughly $110 a barrel, which will make gas more expensive. Some economists have forecast that average gas prices could soon reach $4 a gallon, up from a national average of $3.66 Wednesday.
Costlier energy will send inflation even higher than it otherwise would have been in the coming months, bolstering the case for Fed rate hikes. But more expensive gas also deprives consumers of money to spend on other things. This, in turn, will likely hold down consumer spending and potentially weaken the economy – a scenario that would usually discourage the Fed from raising rates.
