CHRISTOPHER ROOGABER
WASHINGTON (AP) – Amid soaring inflation and falling unemployment, the Federal Reserve said Wednesday it will cut support to the economy more quickly and expects interest rates to rise three times next year.
Fed Chairman Jerome Powell said the US economy is growing “at a steady pace” despite the risks of the pandemic, and believes that spending by businesses and consumers will remain high. But since inflation is likely to persist longer than the Fed previously anticipated, Powell said the central bank must address this threat to help the economy sustain its growth.
“We will use our tools both to support the economy and a strong labor market and to prevent higher inflation from entrenching,” Powell said at a news conference.
In the wake of the sharp change in policy, the Fed said it will withdraw its monthly bond purchases twice as fast as it previously announced and will likely end them in March. The accelerated schedule puts the Fed on the path to raising rates in the first half of next year.
The Fed’s new forecast that it will raise its benchmark short-term rate three times next year surpassed just one rate hike it had forecast in September. The Fed’s key rate, which is now anchored near zero, affects many consumer and business loans, including mortgages, credit cards and car loans.
These borrowing costs may start to rise in the coming months, although the Fed’s actions do not always immediately affect other lending rates. And even if the central bank does raise rates three times next year, it will still keep its base rate at its historically low level, below 1%.
The policy change reflects a recognition by Fed policymakers that with inflationary pressures rising, the Fed needs to start tightening lending to consumers and businesses faster than they expected just a few weeks earlier. The Fed has previously described the surge in inflation as largely a “temporary” problem that will go away as the supply bottlenecks caused by the pandemic are removed. The shift was evidenced by Powell’s testimony to Congress two weeks ago.
The rise in prices continued longer than the Fed expected, and spread from goods such as food, energy and cars to services such as apartment rentals, food in restaurants and hotel rooms. This hit consumers hard, especially low-income households, especially for basic necessities, and offset the higher wages that many workers received.
At a press conference on Wednesday, Powell was asked what exactly prompted the Fed to move to tighten credit policy.
“It was significantly higher inflation and faster progress in the labor market,” he said.
He acknowledged the possibility that inflation will not fall as expected next year.
“There is a real risk now,” Powell said, “that inflation could be more resilient, that inflation expectations could be under pressure, and that the risk of higher inflation entrenching itself has increased. I think part of the reason we are taking this step today is to empower ourselves to deal with this risk. ”
Collectively, Fed officials predict on Wednesday that inflation, measured on their preferred scale, will hit 5.3% by the end of the year, up from 5% in October. They expect inflation to slow down significantly to 2.6% per annum by the end of 2022. But this is more than the September forecast of 2.2%.
Officials forecast the unemployment rate to drop to 3.5% by the end of next year, which will be in line with the level before the pandemic, when unemployment was at its lowest level in 50 years.
The Fed is buying $ 90 billion in bonds a month, up from $ 120 billion in October, and is cutting those purchases by $ 15 billion a month. But in January he will cut those purchases by $ 30 billion, to $ 60 billion, and, Powell said, will be on track to end it entirely in March. The purchase of bonds was aimed at lowering long-term interest rates and encouraging increased borrowing and spending.
The Fed is shifting its focus from cutting unemployment, which fell quickly to a healthy 4.2%, from 4.8% at its last meeting, to curbing price increases. Consumer prices rose 6.8% in November over last year, the fastest pace in nearly four decades, the government said last week.
On Wall Street, stock prices rallied gradually and then rallied sharply after the Fed issued a statement and Powell began speaking at a press conference. By the time Powell finished, the Dow Jones Industrial Average had jumped more than 300 points.
The Fed’s policy change is indeed risky. Rising borrowing costs too quickly can hold back consumer and business spending. This, in turn, will weaken the economy and is likely to increase unemployment.
However, if the Fed waits too long for a rate hike, inflation could spiral out of control. Then he may have to act aggressively to tighten lending and potentially trigger another recession.
Fed officials said they expect inflation to drop by the second half of next year. Gas prices have already dropped from their peak. Supply chain bottlenecks in some areas are gradually decreasing. And government stimulus payments, which fueled spending spikes that spurred inflation, are unlikely to return.
Nonetheless, many economists expect high prices to continue. That likelihood was confirmed this week by a government report that wholesale inflation jumped 9.6% in the 12 months ended November, the fastest year-on-year pace of a 2010 record.
Economists at Goldman Sachs estimate that housing costs, including rent and home ownership, which account for about one-third of the CPI, have grown 5% per year in the past few months. In November, restaurant prices jumped 5.8% from a year ago, an almost four-year high, in part due to higher payroll costs. Such an increase is likely to keep inflation well above the Fed’s annual target of 2% next year.
At his press conference, Powell noted that consumers – the leading engine of the economy – remain on a solid footing.
“Basically,” he said, “the consumer is really healthy and we expect personal consumption spending to be quite high” in the current fourth quarter of the year.
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AP economics writer Martin Krutsinger contributed to this report.
