Powell warns of ‘some pain’ ahead as Fed battles to reduce inflation

Federal Reserve Chairman Jerome Powell made a stark pledge on Friday to contain inflation, warning that he expects the central bank to continue raising interest rates in a way that will cause “some painful” for the US economy.

In his much-anticipated annual policy speech in Jackson Hole, Wyoming, Powell asserted that the Fed will “use our tools vigorously” to attack inflation that is still near the highest level in more than 40 years.

Even with a series of four consecutive rate hikes totaling 2.25 percentage points, Powell said there is “no place to stop or pause” although the benchmark rate could be around a zone. areas that are not considered to stimulate or limit growth.

“While higher interest rates, slower growth and softer labor market conditions will reduce inflation, they will also bring some pain to households and businesses,” he said in the notes. prepared speech. “These are unfortunate costs to reducing inflation. But failing to restore price stability will mean much greater pain.”

Short term stocks losses linger when Powell starts speech, with the Dow Jones Industrial Average falling nearly 200 points. The market then stabilized, with the Dow descending. Treasury yields fell off session highs.

The comment comes amid signs that inflation may have peaked but shows no sign of slowing down.

Two closely watched metrics, the consumer price index and the personal expenditure price index, shows little change in price in Julylargely due to the sharp drop in energy costs.

At the same time, other sectors of the economy are slowing down. Housing in particular is falling rapidly in price, and economists expect that the dramatic increase in hiring over the past year and a half is likely to cool down.

However, Powell warned that the Fed’s focus is broader than a month or two of data and it will continue to push until inflation falls closer to its 2 percent long-term target.

“We are shifting our policy stance on purpose to the point where it is restrained enough to bring inflation back to 2%,” he said. Looking to the future, the central bank leader added that “the restoration of price stability is likely to require maintaining a restrictive policy stance for a while. The historical record strongly warns against easing policy too soon.”

The economy is experiencing consecutive quarters of negative GDP growth, a common definition of a recession. Still, Powell and most other economists see the underlying economy as strong if it slows.

“In essence, Powell is making it clear that right now, it’s more important to fight inflation than to support growth,” said Jeffrey Roach, chief economist at LPL Financial.

To the point

The speech was unusually brief.

While Fed leaders, including Powell, often use the Jackson Hole symposium as an opportunity to map out broad policy changes, Powell’s remarks on Friday came in just about eight minutes. minute.

He introduced the speech by noting that “his remarks will be shorter, my focus narrower, and my message more direct.”

“Price stability is the responsibility of the Federal Reserve and serves as the foundation of our economy,” he said. “Without price stability, the economy doesn’t work for anyone.”

Markets await the Fed’s next meeting in September to see if the Federal Open Market Committee will set interest rates to see if it enacts a third straight 0.75% hike. or not. Powell said the decision “will depend on the total amount of data coming in and the outlook for developments. At some point, as the stance of monetary policy tightens further, it is likely to become appropriate to slow down the rate of increase.”

Traders are currently pricing a call close to between a half point and three quarter point gain. As of Friday morning right after Powell’s speech, the probability for a half-point move was 51.5%, according to CME Group’s FedWatch gauge.

Looking back at history

The Fed is using a lesson from the past as a guide for current policy.

Specifically, Powell said the inflation of 40 years ago provides the current Fed with three lessons: Central banks like the Fed are responsible for managing inflation, that expectations are important, and that “we must maintain maintain it until the job is done.”

Powell noted that the Fed’s inability to act aggressively in the 1970s caused a prolongation of high inflation expectations, leading to draconian rate hikes in the early 1980s. In that case, the Fed Chair when it was Paul Volcker who pulled the economy into recession to tame inflation.

While he has repeatedly stated that he does not think a recession is an inevitable outcome for the US economy, Powell noted that managing expectations is crucial if the Fed is to avoid a Volcker-like outcome. .

In the early 1980s, “a long period of very restrictive monetary policy was finally needed to prevent high inflation and begin the process of bringing inflation down to a low and stable level, which is the norm for inflation.” until last spring,” Powell said. “Our aim is to avoid that outcome by acting with determination now.”

One concept that sums up Powell’s thinking is the concept of “rational inattention”. It basically means that people pay less attention to inflation when it is low and more when it is high.

“Inflation is, of course, in the spotlight right now, which highlights a particular risk right now: The longer the current high inflation continues, the more likely it is to expect Higher inflation will become more difficult,” he said.

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