WASHINGTON – With inflation soaring and unemployment falling, the Federal Reserve said on Wednesday it would cut back its support for the economy more quickly and plan to hike interest rates three times next year.
Fed Chairman Jerome Powell has said the US economy is growing at a “steady pace” even as it faces the risks of the pandemic, and he believes business and consumer spending will remain strong . But because inflation is expected to persist longer than the Fed previously predicted, Powell said the central bank must deal with the threat to help the economy maintain its expansion.
“We will use our tools both to support the economy and a strong labor market and to prevent higher inflation from taking hold,” Powell said at a press conference.
In a radical policy change, the Fed announced that it would withdraw its monthly bond purchases at double the previously announced rate and likely end them in March. The accelerated schedule puts the Fed on track for a rate hike as early as the first half of next year.
The Fed’s new forecast that it will hike its short-term benchmark rate three times next year is up from a single rate hike it forecast in September. The Fed’s key rate, now close to zero, influences many consumer and business loans, including mortgages, credit cards and auto loans.
These borrowing costs could 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 were to raise rates three times next year, it would still leave its benchmark rate at a historically low level, below 1%.
The policy change reflects the recognition by Fed policymakers that with increasing inflationary pressures, the Fed needed to start tightening credit to consumers and businesses faster than they expected a few weeks earlier. . The Fed had previously characterized the spike in inflation as primarily a “transitional” problem that would subside as supply bottlenecks caused by the pandemic were resolved. The change was pointed out in the testimony Powell gave to Congress two weeks ago.
The rise in prices persisted longer than the Fed expected, and spilled from goods like food, energy and automobiles to services like apartment rents, restaurant meals and rooms. hotel. It took a heavy toll on consumers, especially low-income households and especially for daily necessities, and canceled the higher wages many workers received.
Powell was asked at his press conference on Wednesday what specifically prompted the Fed to adopt a stricter credit policy.
“It was basically higher inflation and much faster progress in the job market,” he said.
He acknowledged the possibility that inflation might not fall as expected next year.
“There is a real risk now,” said Powell, “that inflation may be more persistent and that may put pressure on inflation expectations, and that the risk of higher inflation taking root has increased. I think part of the reason for our decision today is to put ourselves in a position to deal with that risk. “
Collectively, Fed policymakers predict on Wednesday that inflation, as measured by their preferred indicator, will hit 5.3% by the end of the year, from 5% in October. They expect inflation to slow significantly to an annual rate of 2.6% by the end of 2022. But that’s up from its September forecast of just 2.2%.
Officials predict the unemployment rate will drop to 3.5% by the end of next year, which would be in line with pre-pandemic levels, when unemployment was at its lowest in 50 years.
The Fed buys $ 90 billion in bonds per month, up from $ 120 billion in October, and had reduced those purchases by $ 15 billion per month. But in January, he will cut those purchases from $ 30 billion, to $ 60 billion, and be on track, Powell said, to end them completely in March. The purpose of buying bonds was to lower long-term interest rates and encourage more borrowing and spending.
The Fed is diverting its attention from reducing unemployment, which has fallen rapidly to 4.2% from 4.8% at its last meeting, and to containing rising prices. Consumer prices rose 6.8% in November from a year earlier, the government said last week, the fastest pace in nearly four decades.
On Wall Street, stock prices gradually rose, then surged after the Fed’s statement was released, and Powell began speaking at a press conference. By the time Powell finished, the Dow Jones Industrial Average had jumped over 300 points.
The Fed’s policy change comes with risks. Rising borrowing costs too quickly could stifle consumer and business spending. This, in turn, would weaken the economy and likely increase unemployment.
Yet if the Fed waits too long to raise rates, inflation could get out of hand. He may then have to act aggressively to tighten credit and potentially trigger another recession.
Fed officials have said they expect inflation to slow down by the second half of next year. Gas prices are already out of their peaks. Supply chain bottlenecks in some regions are gradually easing. And the government’s stimulus payments, which helped spur higher spending that boosted inflation, are not expected to return.
Still, many economists expect high prices to persist. That likelihood was bolstered this week by a government report that found wholesale inflation jumped 9.6% for the 12 months ending in November, the fastest year-over-year pace on the records dating from 2010.
Housing costs, including apartment rents and the cost of ownership, which account for about a third of the consumer price index, have increased at an annual rate of 5% in recent months, calculated Goldman Sachs economists. Restaurant prices jumped 5.8% in November from a year ago, a high of nearly four decades, partly reflecting rising labor costs. Such increases will likely keep inflation well above the Fed’s 2% annual target next year.
During his press conference, Powell noted that consumers – the main engine of the economy – remain on solid footing.
“Basically,” he said, “the consumer is really healthy and we expect personal consumption spending to be pretty strong” in the fourth quarter of this year.
AP Economics writer Martin Crutsinger contributed to this report.