With the economy and inflation set to surge this year as the nation emerges from the COVID-19 recession, the Federal Reserve is starting to ease back from pandemic era policies aimed at jolting growth.
Citing an upgraded economic outlook and a spike in inflation, the Fed on Wednesday held its key interest rate near zero and vowed to maintain its bond buying stimulus, but it’s now forecasting two rate hikes in 2023, up from none previously.
Fed officials foresee its benchmark short-term rate at a range of 0.5% to 0.75% in 2023, acdording to their median estimate.While most of the officials said they want to hold the rate near zero through next year, only five foresee rates at that level in 2023. Two prefer one rate increase in 2023, while three envision two hikes and eight foresee an even higher rate by then.
Fed officials “are more comfortable that (the economic conditions for raising rates) will be met somewhat sooner than previously anticipated,” Fed Chair Jerome Powell said at a news conference. “We’re going to be in a strong labor market pretty quickly here.”
“Progress on vaccinations will likely continue to reduce the effects of the public health crisis on the economy, but risks to the economic outlook remain,” the Fed said in a statement after a two-day meeting.
Yet Powell noted Fed officials’ rate forecasts are merely estimates, adding that “liftoff is well into the future.” In its statement, the Fed reiterated it would keep its benchmark short-term rate near zero until the economy returns to full employment and inflation has risen above its 2% target “for some time.”
Powell said the Fed’s focus in the short term is on when to begin tapering its bond purchases. The central bank repeated that it would continue to purchase $120 billion a month in Treasury bonds and mortgage-backed securities to hold down long-term rates “until substantial further progress has been made toward” the Fed’s employment and inflation goals.
Powell said the Fed discussed reducing the purchases this week and would provide more guidance “at a future meeting.”
‘A ways from our goal’
“The economy has made progress but it’s still a ways from our goal of substantial progress,” he said, declining to provide a timetable for tapering. Some top economists think the Fed will begin paring back the purchases early next year.
The Fed also boosted its economic forecast, predicting growth of 7% this year, up from 6.5% at its March meeting, before slowing to a still healthy 3.3% pace in 2022. It projects unemployment will fall from 5.8% to 4.5% by year-end. Fed officials believe a core inflation measure that strips out volatile food and energy items will close the year at 3% before dropping back down to 2.1% in 2022.
While Powell told reporters that officials still believe the current climb in inflation is “transitory,” he added, “Inflation could turn out to be higher and more persistent than we expect.” That could force the Fed to pull back its stimulus measures earlier.
The central bank is grappling with conflicting signals. The U.S. economy is close to completely reopening, COVID-19 cases have plunged and more than half the adult population is fully vaccinated. Americans also have saved about $2.5 trillion in aggregate as a result of government stimulus checks and a year of COVID-19 restrictions and are they’re eager to bust out.
Yet employment growth, while brisk by historical standards, has been less robust than anticipated, with an average 418,000 jobs a month added in April and May, about half the tally economists expected.
The shortfall largely has been blamed on worker shortages, with many Americans still caring for children who are distance-learning from home or preferring to stay on enhanced unemployment insurance. Those hurdles are likely to fade by fall as schools reopen and the extra jobless benefits run out.
Inflation heats up
Meanwhile, however, a core measure of inflation that the Fed watches closely increased 3.1% annually in April, up from 1.9% the prior month and well above the Fed’s 2% target. Fed officials largely have downplayed the rise as a temporary byproduct of a reopening economy and supply-chain bottlenecks that have caused myriad product shortages.
Powell noted most of the price increases are for products and services related to the reopening economy, such as air fares and used cars, which have been plagued by shortages tied to manufacturing snarls.
Some analysts believe the price increases could be more enduring as the labor shortages push up wages and lead consumers and businesses to expect stronger inflation.
Before the Fed’s statement was released, Goldman Sachs reckoned it was too soon for the central bank to hint at tapering the bond buying because the labor market – Powell’s chief priority – “has not yet come far enough.”
“We’re on a good path, but we are a long way from home,” Chicago Fed President Charles Evans said last month.
“This is a Fed that is focused on the labor market first and will let inflation run hot to get the labor market back to its pre-pandemic peak,” economist Steven Ricchiuto of Mizuho Securities USA wrote in a note to clients after the Fed released its statement.
Still, the Fed is taking small steps toward withdrawing some stimulus strategies. Oxford thinks the Fed will formally announce the tapering plan in August or September, and begin reducing purchases early next year.
Fed officials are especially sensitive about hinting at such tapering because unexpected comments about paring back the bond program 2013 caused a leap in U.S. Treasury yields.
“It may be time to at least think about thinking about tapering,” Philadelphia Fed president Patrick Harker said this month.
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This article originally appeared on USA TODAY: The Federal Reserve: Fed now foresees first rate hikes in 2023