Federal Reserve policymakers now think inflation will run hotter than previously expected this year, but the central bank still believes price hikes will moderate in 2022 as pandemic pressures fade.
At the conclusion of a two-day policy meeting Wednesday, members of the Fed's rate-setting committee predicted an annual inflation rate of 4.2% by year's end. That's up from 3.4% they were forecasting in June. However, inflation is still expected to cool to about 2.2% next year.
Fed chairman Jerome Powell argues much of the upward pressure on prices is the result of supply-chain bottlenecks and shortages, resulting from the pandemic.
"These bottleneck effects have been larger and longer-lasting than anticipated," Powell said. "While these supply effects are prominent for now, they will abate. And as they do, inflation is expected to drop back toward our longer-run goal."
The Fed's preferred yardstick for inflation is the index of personal consumption expenditures (PCE) compiled by the Commerce Department. The PCE showed an inflation rate of 4.2% in July, the most recent data available.
Inflation is running well above the Fed's long-term target of 2%, and a growing number of Fed policy makers now see a path to raising interest rates as early as next year. Interest rates are currently near zero.
Nine members of the committee suggested it may be appropriate to raise rates as early as next year — up from seven who said so in June. Nine other members of the rate-setting committee don't expect to raise interest rates until 2023 or later.
The Fed also sees slightly slower economic growth
Meanwhile, committee members think the U.S. economy will grow by 5.9% this year, a slight downshift from three months ago, when they were forecasting gross domestic product (GDP) growth of 7%. That could be partially offset by somewhat faster-than-expected growth in 2022.
U.S. employers added just 235,000 jobs in August after adding more than a million jobs the month before. A surge in new coronavirus cases tied to the delta variant likely discouraged people from traveling, eating out and attending live entertainment. At the same time, uncertainty about in-person schooling has made it harder for parents to return to work.
"What happened was, delta happened," Powell said.
The central bank has been buying at least $120 billion worth of Treasury and mortgage securities each month, in an effort to support the economy and keep long-term interest rates low.
Powell said a formal decision to begin slowing those bond purchases could come as early as the next Fed meeting in November. But the central bank cautioned the pace of the economic recovery remains uncertain.
"The path of the economy will depend significantly on the course of the virus," the Fed said in a statement. "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 has promised to provide ample warning before any policy change, in hopes of calming investors. The stock market, which was rattled earlier this week by the threat of a debt default by Chinese property developer Evergrande Group, rebounded on Wednesday. The Dow Jones Industrial Average rose more than 335 points or nearly 1%.
The Fed met at a sensitive time for Powell
Nervous investors have also been eyeing the drawn-out battle in Congress over efforts to raise the federal debt ceiling. Powell warned of severe damage to the economy and the markets if lawmakers don't act quickly to authorize additional borrowing so the government can continue to pay its bills.
"No one should assume the Fed or anyone else can protect the markets or the economy in the event of a failure to make sure that we do pay those debts when they're due," Powell said.
This week's meeting comes at a sensitive moment for the Fed chairman, whose term expires in February.
President Biden has to decide whether to reappoint Powell — a Republican who was promoted to the chairman's seat by former President Donald Trump — or go with an alternate candidate as some progressive Democrats have urged him to do. A possible alternative is Lael Brainard, who currently serves on the Fed's Board of Governors.
Powell ducked a question about whether he's had any communication with the White House about the appointment.
"I think the phrase goes, 'I have nothing for you on that today,'" Powell said, adding he's focused on doing his job.
AUDIE CORNISH, HOST:
The Federal Reserve says inflation will be somewhat higher than expected this year, but the central bank still believes it will cool off next year. So the Fed is leaving interest rates where they are - near zero - at least for the time being. A growing number of Fed policymakers now see a path to raising interest rates, but not until 2022. NPR's Scott Horsley joins us now. Hey there, Scott.
SCOTT HORSLEY, BYLINE: Good afternoon, Audie.
CORNISH: So, of course, the Fed is the main regulatory body keeping an eye on inflation in the U.S. Prices are rising faster than a lot of Fed officials had expected. How do they understand it?
HORSLEY: Well, the Fed acknowledged that it has underestimated inflationary pressure for much of this year. The Fed's preferred yardstick for price hikes measure inflation at 4.2% during the summer, and the latest forecast out this afternoon shows Fed officials think inflation will still be running about that level by the end of this year. Now, that's higher than they were forecasting in June and a lot higher than they were forecasting in March. Fed Chairman Jerome Powell says a lot of that upward pressure on prices is the result of supply bottlenecks tied to the pandemic.
(SOUNDBITE OF ARCHIVED RECORDING)
JEROME POWELL: These bottleneck effects have been larger and longer-lasting than anticipated. While these supply effects are prominent for now, they will abate. And as they do, inflation is expected to drop back toward our longer-run goal.
HORSLEY: By next year, Fed officials expect to see inflation settling down to around 2.2%.
CORNISH: At the same time, the Fed has also lowered its forecast for economic growth. What was the reason they gave for that?
HORSLEY: In a word, delta. The rise in coronavirus cases tied to the delta variant has both depressed demand for eating out and traveling and in-person entertainment, and it's also made people more cautious about going back to work. As a result, the Fed dialed back its GDP forecast from 7% for this year to 5.9%.
That is still pretty strong, though; strong enough for the central bank to think about reducing its extraordinary support for the economy later this year. And as you mentioned, half the members of the rate-setting committee now think they might be ready to actually raise interest rates as early as next year.
CORNISH: What's the market response, so to speak?
HORSLEY: I think this is pretty much what the market expected. The Dow actually closed up today more than 330 points after a big sell-off earlier in the week. Now, that sell-off was tied to worries about a default by that big Chinese property developer, Evergrande.
Investors are also a little jittery as Congress continues to play a game of chicken with the debt ceiling. And Chairman Powell warned it would do serious damage to the economy if lawmakers don't authorize additional borrowing in a timely fashion so the government can keep paying its bills.
(SOUNDBITE OF ARCHIVED RECORDING)
POWELL: You know, no one should assume that the Fed or anyone else can protect the markets or the economy in the event of a failure to make sure that we do pay those debts when they're due.
CORNISH: Briefly, Scott, Powell's term as Fed chairman is actually up in February. Was he actually asked about that at all?
HORSLEY: He was asked. You know, President Biden is in the midst of deciding whether to reappoint Powell, who is a Republican who was promoted to the job by former President Donald Trump. Powell generally gets high marks for his management during the pandemic and would almost surely win easy confirmation if Biden does offer him a second term, but some progressive Democrats would like to see somebody else in the job. Powell was asked if he even wants to be reappointed, and here's his politically practiced answer.
(SOUNDBITE OF ARCHIVED RECORDING)
POWELL: I think the phrase goes, I have nothing for you on that today.
HORSLEY: The Fed chairman says for now, he's just focused on doing his job.
CORNISH: That's NPR's Scott Horsley. Thank you, Scott.
HORSLEY: You're welcome.
(SOUNDBITE OF REAL ESTATE SONG, "DARLING") Transcript provided by NPR, Copyright NPR.