Despite the Russian invasion of Ukraine and a plummeting stock market, Federal Reserve Chairman Jerome Powell told Congress on Wednesday that the central bank plans to raise its key interest rate from near zero this month to combat a historic spike in inflation.
Powell said he would suggest a quarter-point increase, rather than a half-point, indicating that that’s likely what the Fed’s policymaking committee will agree to.
“With inflation above 2% and labor market strength, we expect it will be appropriate to raise the target range for the federal funds rate at our meeting later this month,” Powell said at a House Financial Services Committee hearing. “I would say we will proceed with caution along that plan.”
“I am inclined to suggest and support an interest rate increase of 25 basis points,” he added.
However, he indicated that the Fed is ready to raise interest rates more sharply, depending on the effects of the Ukraine war and other developments.
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Powell’s comments underscore broad expectations about the Fed’s first rate hike in more than three years after he told reporters in late January that officials were “intent” to raise rates in the short term, assuming the conditions were right for us to do so. “
Since then, the Ukraine war has driven up oil and gasoline prices, further clogging the country’s supply chains and intensifying the stock market sell-off.
But Powell said in his written testimony, “The short-term effects on the US economy of the invasion of Ukraine, the ongoing war, sanctions, and upcoming events, remain highly uncertain… We will need to be smart and responsive to the incoming data and the evolving outlook.”
So far this year, Powell said, the economy has been solid, with “strong” job gains in January bringing the unemployment rate down to 4%.
“The rapid spread of the omicron variable led to some slowdown in economic activity early this year, but with cases dropping sharply since mid-January, the slowdown appears to have been brief,” Powell said.
Meanwhile, the Fed’s preferred annual inflation measure reached 6.1% in January, while the consumer price index came in at 7.5%, the highest in 40 years.
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Powell said the Fed expects price hikes to subside as supply chain bottlenecks ease, household demand moderates, as consumers exhaust their stimulus checks and other government aid from last year, and the Fed raises interest rates.
“But we are mindful of the risks of potentially increasing upward pressure on inflation expectations and inflation itself from a number of factors,” Powell said in the prepared text.
“We know that the best thing we can do to support a strong labor market is to promote prolonged expansion, and this is only possible in an environment of price stability,” he added.
War is likely to exacerbate inflation, but it could also slow the economy through higher pump prices and lower inventories. This poses a dilemma for Fed policy makers as they are weighing how sharp interest rate hikes will be this month and the rest of the year.
The Fed raised interest rates to discourage borrowing, cool an overheating economy and avoid rising inflation. It lowers them to stimulate borrowing, economic activity, and job growth.
Some Fed officials said they would prefer a half-point hike at the March 15-16 meeting to show their determination to fight high prices. But top economists said a quarter-point move became more likely after the war threatened to stymie growth, and Powell appeared to confirm that on Wednesday.
Powell also plans to tell lawmakers that the Fed will begin trimming its bloated balance sheet “after the rate hikes begin, and will continue to operate in a predictable manner primarily through adjustments to reinvestments.”
Since March 2020, the Fed has bought $4.5 trillion in Treasuries and mortgage-backed securities, initially to stabilize the financial system and then to lower long-term rates for consumers and businesses.
The Fed said it would gradually reduce holdings by not reinvesting proceeds from certain assets as they mature rather than selling bonds outright, which could disrupt markets. Sales are more likely to pay long-term rates, such as mortgages.
Some economists expect the central bank to start reducing the balance sheet in June or July.
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