Powell Says Fed Still Expects Inflation to Ease

Pandemic-related bottlenecks and other supply constraints created “just the perfect storm of high demand and low supply” that led to rapid price increases for certain goods and services, he said. Higher inflation readings “should partially reverse as the effects of the bottlenecks unwind.”

Mr. Powell also indicated he wasn’t in a hurry to start paring the Fed’s monthly purchases of $120 billion in Treasury or mortgage securities. Several Fed bank presidents have indicated they are eager to start shrinking those purchases. Other senior Fed officials have suggested the central bank shouldn’t be in a rush.

“We’ll have another round of discussions on this very topic” at the Fed’s meeting in two weeks, he said. Mr. Powell didn’t suggest that any decisions are imminent.

The Fed has held interest rates near zero since the coronavirus pandemic hit the U.S. economy in March 2020. The central bank has said it expects to keep rates there until it is confident inflation will hold at its 2% target and the labor market has healed, or returned to what it calls “maximum employment.”

The central bank also has committed to continuing its bond purchases until achieving “substantial further progress” toward its inflation and employment goals.

Mr. Powell said the economy “is still a ways off” from reaching that standard, but officials expect progress to continue.

While the Fed and many private-sector forecasters had expected inflation to rise this year as a surge in consumer spending collided with pandemic-related shortages and bottlenecks, the strength of the last three monthly inflation readings has been greater than many anticipated. While inflation is expected to decline, questions abound over how soon and how low inflation will fall relative to the Fed’s 2% target.

U.S. consumer prices continued to accelerate in June at the fastest pace in 13 years as the recovery from the pandemic gained steam. The Labor Department reported Tuesday that its consumer-price index increased 5.4% in June from a year earlier. Excluding volatile food and energy categories, prices rose 4.5% from a year earlier, the most in 30 years.

Mr. Powell said it would be a blunder to raise interest rates to address one-time increases in the prices of certain services, like air travel and hotel rates, or goods, like new and used cars, that have surged due to the reopening of the economy.

“Honestly, it would be a mistake to do it at a time when virtually all forecasters believe that these things will come down on their own accord,” Mr. Powell said. “It would be a mistake to act prematurely.”

There could come a point when “the risks may flip,” he said.

If inflation stayed too high or began to seep into consumers’ and businesses’ expectations of future inflation, which can be self-fulfilling, then the Fed would raise rates. “People need to have faith in the central bank that we will do that,” Mr. Powell added.

Investors and Fed officials are grappling not only with an unexpected blast of price pressures but also with implementing a new policy framework, unveiled in August 2020, designed to seek periods of inflation moderately above 2% after periods below that level. Officials have been vague around exactly what would be an acceptable period or magnitude of above-target inflation.

The recent surge has created an unexpected problem for the Fed because inflation has strongly exceeded that objective. “Inflation is not moderately above 2%. It’s well above 2%. It’s nothing like ‘moderately,’” Mr. Powell said. The question facing the Fed is “where does this leave us in six months or so when inflation, as we expect, does move down?”

Increasingly, the debate is over how far inflation will fall and where it will settle relative to the Fed’s 2% target. Even if supply-side pressures recede, officials may have to sort out whether demand pressures from an expanding economy lead wages and prices to rise or stabilize at appropriate levels.

“They’re right that this is transitory. They’re going to get a respite,” said Steven Blitz, chief U.S. economist at research firm TS Lombard. “But it’s not going to be as big of one as they think.” Mr. Blitz said he expects stronger wage growth next year to allow a more traditional inflationary cycle to take hold.

At last month’s Fed meeting, most officials projected they would need to raise interest rates from near zero by 2023, and most expected to move their benchmark rate up by 0.5 percentage point. Several expected to lift rates next year. The projections surprised many investors because in March, most officials expected to hold rates steady through 2023.

For months, Mr. Powell had used pre-pandemic employment levels as a guide for what might meet a working definition of “maximum employment.” But the Fed’s monetary policy report, released last Friday, suggested officials might be growing less confident about the possibility of returning to the labor market conditions of February 2020 without accepting higher inflation.

Mr. Powell presented the Fed’s semiannual monetary-policy report to members of the House panel on Wednesday and is set to do so again to the Senate Banking Committee on Thursday.

Write to Nick Timiraos at [email protected]