Federal Reserve raises inflation expectations, mulls 2023 liftoff

The United States Federal Reserve reiterated Wednesday that it is willing to tolerate a higher level of inflation as it works towards its goal of getting as many Americans back to work as possible, but upped its comfort level when it comes to how high it is willing to see that rate go.

In remarks following the conclusion of the Fed’s latest two-day policy meeting, Chairman Jerome Powell urged patience and humility as the US economy continues to recover from last year’s COVID-19 lockdowns.

“This is an extraordinarily unusual time and we really don’t have a template or any experience of a situation like this, and so I think we have to be humble about our ability to understand the data,” Powell said. “It’s not a time to try to reach hard conclusions about the labour market, about inflation, about the path of policy. We need to see more data and we need to be a little bit patient.”

The Fed — which is the US’s central bank — wrapped up its fourth meeting of 2021 with an announcement that policy would be left largely unchanged, with interest rates remaining near zero and the Fed’s bond-buying continuing at $120bn per month. The vote to keep interest rates steady was unanimous among the 18 members of the Federal Open Market Committee.

The meeting’s big surprise came courtesy of policymakers’ latest economic projections, which see the Fed’s preferred measure of inflation — personal consumption expenditures (PCE) — rising to 3.4 percent this year, a full percentage point higher than its March forecast of 2.4 percent.

The latest Fed projections see inflation dropping to 2.1 percent next year, as opposed to its March call of 2 percent. It also moved forward its projected timeline on raising interest rates to as soon as 2023. In March, policymakers targeted 2024 as the earliest time for a rate liftoff.

The inflation question

In its post-meeting statement, the Fed maintained that the recent rise in inflation is “largely reflecting transitory factors” such as the economy gearing back up again from its pandemic hibernation — a position Powell echoed in his statements following the meeting.

“Inflation has come in above expectations over the last few months,” said the Fed chief. “But if you look behind the headline numbers, you’ll see that the incoming data are consistent with the view that the prices that are driving that higher inflation are from categories that are being directly affected by the recovery from the pandemic and the reopening of the economy.”

As an example, Powell cited lumber prices, which have climbed recently, stymieing homebuilders’ ability to capitalise on an increase in demand for new homes by Americans seeking more space after a year at home. But Powell said that because those price hikes are the result of shortages and bottlenecks, they should begin to drop eventually.

Progress and risks

In a press release, the Fed hailed “progress” as a widespread vaccination campaign has helped curb COVID-19 infections and deaths in the US, which, along with “strong policy support”, has allowed economic activity and employment to strengthen.

The Fed’s June projections painted a rosier picture for both growth and employment, upping the March projection for 2021 gross domestic product growth by half a percentage point to 7 percent. It also sees the unemployment rate falling to 4.5 percent this year and 3.8 percent next year before returning to the pre-pandemic level of 3.5 percent in 2023.

While sectors such as the hospitality industry that were hardest hit by restrictions aimed at curbing the spread of COVID-19 remain weak, they have also “shown improvement”, the Fed said.

But Powell warned the country wasn’t totally “out of the woods” yet. Concerns about vaccine hesitancy among Americans and fast-spreading strains of COVID-19 including the Delta variant remain.

“The path of the economy will depend significantly on the course of the virus. 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,” said the Fed’s statement.

To mitigate those risks, the Fed said it is willing to tolerate inflation moderately above its 2 percent target rate “for some time” in order to keep the long-term outlook anchored at 2 percent.

Rising prices

Inflation has become a buzzword in the world’s largest economy as American consumers’ pent-up demand to spend after a year at home runs up against supply chain headaches, a scramble for raw materials and rising producer prices.

As the Fed leaders sat down for the first day of their meeting Tuesday, fresh data released this week showed that producer prices continue to climb as countries that are reopening battle supply-chain bottlenecks and contend with higher costs of raw materials for factories.

Food and energy prices led the advance higher in the US government’s Producer Price Index, with food prices jumping 2.6 percent last month and energy prices climbing 2.2 percent after contracting in April.

Higher producer prices translate into higher costs for wholesalers, who saw prices rise a record 0.8 percent in May on a monthly basis and a blistering 6.6 percent over the past 12 months – the biggest jump on record, according to data from the US Bureau of Labor Statistics (BLS).

Those snowballing costs then translate into higher prices for consumers, which hit people with lower incomes particularly hard because their wages don’t stretch as far as they used to and they have less disposable income to start.

The data shows that’s already happening: US consumer prices rose a brisker-than-expected 0.6 percent in May, another uptick after April’s 0.8 percent rise. Because consumer spending is responsible for two-thirds of the US’s economic growth, pain in the pocketbook has broader consequences.

The fear is that if price increases get out of control, the Fed will be forced to raise interest rates, which makes borrowing money more expensive and curbs economic growth.

But Powell reassured Americans on Wednesday that the Fed is sticking to its plan of keeping rates near zero until the labour market fully recovers.

Getting the US back to work

Americans are still spending, albeit on different things. Retail sales in May fell a bigger-than-expected 1.3 percent from a month earlier, the United States Department of Commerce said on Tuesday, as consumers spent less at car dealerships and at furniture, electronic and home improvement stores.

Instead, the advent of summer seems to be motivating Americans to spend more on personal care products and food and beverages as many parts of the country further lift restrictions on gyms, restaurants, bars and hotels.

But the battered hospitality sector continues to have a hard time attracting workers. Eating and drinking establishments added a net 186,000 jobs in May, the fifth straight month of gains, according to BLS data. But staffing levels in May remained 12 percent below pre-pandemic levels, the National Restaurant Association found.

The staffing shortage is being driven by a number of factors, experts say, from bottlenecks and workers who can’t find childcare to people switching careers.

Some are also blaming the $300 federal top-up to state unemployment benefits, which they argue acts as a disincentive for people to go out and find jobs. Twenty-five states have announced plans to withdraw from the federal unemployment benefits programme, which includes the $300 weekly top-up. All of those states are led by Republican governors.

Yet Powell predicted a stronger labour market than ever before if the US can stay the course in the recovery, and he signalled that as children return to school, vaccination rates continue to increase and some federal unemployment benefits expire, many more Americans will return to work in the short term.

In the long term, Powell painted an even more positive picture.

“I think it’s clear and I am confident that we are on a path to a very strong labour market — a labour market that shows low unemployment, high participation and rising wages for people across the spectrum,” Powell said. “That’s shown in our projections. It’s shown in outside projections. And if you look through the current timeframe and think one and two years out, we’re going to be looking at a very, very strong labour market.”