Powell signals Fed will soon cut back on stimulus

Federal Reserve Chairman Jerome Powell said Friday that inflation has risen enough to warrant a reduction in the central bank’s support for the recovering economy, potentially by the end of the year.

In a Friday virtual speech, Powell said that the rate of price increases had achieved the “substantial further progress” necessary for the Fed to begin reducing its $120 billion in monthly bond purchases, and he expects the labor market to strengthen to that point as well soon.

“At the FOMC's recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year,” Powell said, referring to the Federal Open Market Committee, the Fed’s monetary policy arm.

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“The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the delta variant. We will be carefully assessing incoming data and the evolving risks. Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions.”

Powell’s speech comes as the Fed faces growing pressure from some central bank officials, lawmakers and economists to begin cutting back on monetary support for the economy nearly a year and half after the onset of the COVID-19 pandemic.

The Fed in March 2020 cut its baseline interest rate range to 0 to 0.25 percent and pledged to purchase at least $120 billion each month in Treasury and mortgage bonds to stabilize financial markets amid the onset of the pandemic. While experts say those efforts helped prevent a deeper crisis and clear a path for a faster recovery, a growing number of Fed officials and economists think it's time for the bank to taper, with inflation persisting well above its target level.

Inflation as measured by the personal consumption expenditure price index, the Fed's preferred gauge, rose 0.3 percent in July and 4.2 percent annually last month, according to data released Friday. The Fed's target level of inflation is an annual average of 2 percent.

While inflation had been expected to exceed the Fed's target after prices declined in 2020, the rate of price increases has exceeded the projections of the central bank and most economists. Even so, Powell expressed confidence that inflation would retreat to normal levels as the economy shakes off several short-term pandemic-related restraints.

"Inflation at these levels is, of course, a cause for concern. But that concern is tempered by a number of factors that suggest that these elevated readings are likely to prove temporary," Powell said, reiterating a case that he, White House economic officials and many other economists have made for months.

Powell highlighted five main reasons why he did not expect inflation to spiral out of control: the fact that it has been driven by a "relatively narrow group of goods and services that have been directly affected by the pandemic;" declining price increases in heavily affected goods; wages rising in line with a 2 percent inflation rate; longer-term inflation expectations staying stable; and decades of technology and globalization making goods and services cheaper.

"While the underlying global disinflationary factors are likely to evolve over time, there is little reason to think that they have suddenly reversed or abated. It seems more likely that they will continue to weigh on inflation as the pandemic passes into history," he said.

Powell also argued that pulling back support too quickly to fend off a temporary spike in inflation could have devastating long-term effects for the economy, particularly as women, African Americans and Hispanics climb back from a disproportionate toll from the pandemic.

"The ill-timed policy move unnecessarily slows hiring and other economic activity and pushes inflation lower than desired. Today, with substantial slack remaining in the labor market and the pandemic continuing, such a mistake could be particularly harmful," he said.

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"We know that extended periods of unemployment can mean lasting harm to workers and to the productive capacity of the economy."

Fed watchers said Powell's speech largely aligned with expectations and hinted toward the start of a tapering process in November. 

“While giving a nod to the significant progress the economy has seen, the Delta variant is enough of a near-term risk that Fed Chair Powell feels it is too early to announce any details on tapering bond purchases. The arrival of August economic figures throughout September should provide more clarity and could trigger such an announcement at the September 21-22 meeting," wrote Greg McBride, chief financial analyst at Bankrate, in a Friday analysis.

But Powell emphasized that the eventual reduction of bond purchases would not influence how soon the Fed hikes interest rates. While the bank will likely slow bond purchases before the labor market fully heals, Fed officials have ruled out hiking rates until the economy nears maximum employment.

"We have much ground to cover to reach maximum employment, and time will tell whether we have reached 2 percent inflation on a sustainable basis," Powell said. 

"Despite today's challenges, the economy is on a path to just such a labor market, with high levels of employment and participation, broadly shared wage gains, and inflation running close to our price stability goal," he concluded.

—Updated at 11:27 a.m.