Federal Reserve chair signals smaller rate hikes as bank keeps up inflation fight

WASHINGTON - The Federal Reserve is preparing to slow the rapid pace of its interest rate hikes but will likely keep borrowing costs higher for longer than previously expected to get the economy on stable footing, the central bank’s chief said on Wednesday.

In a speech at the Brookings Institution, Fed Chair Jerome H. Powell said the central bank saw some signs that inflation was easing in the costs of goods and housing, but that the tight labor market remained a problem for controlling prices. The Fed has made huge moves to get interest rates high enough to slow the economy. And Powell said it makes sense for officials to “moderate the pace” of those increases as soon as the central bank’s upcoming meeting in mid-December.

More important, though, will be how much further rates climb next year, and how long it will be necessary to hold them high enough to slash inflation and bring the labor market into sync with the broader economy’s needs.

“It is likely that restoring price stability will require holding policy at a restrictive level for some time,” Powell said. “History cautions strongly against prematurely loosening policy. We will stay the course until the job is done.”

The remarks come as financial markets appear to be anxious for any signs that the Fed is ready to ease up on its historic rate hike campaign. Markets were jittery early Wednesday afternoon as investors waited for Powell’s speech, but quickly flashed green on Powell’s speech.

Powell has said that the Fed’s inflation fight will inflict some pain on households and businesses. But a long-feared recession has yet to arrive, and key pillars of the economy remain remarkably resilient to higher rates. The widely held expectation is that the economy will slow drastically next year, and inflation has brought tremendous uncertainty to every sector. But there is no precedent for the post-pandemic economy, and Powell’s job is to give some insight into his thinking while acknowledging how confounding the outlook remains.

“The truth is that the path ahead for inflation remains highly uncertain,” Powell said.

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For the Fed to win its inflation fight, Powell said production bottlenecks must keep easing, though he acknowledged that they’re already on the right path. Inflation on new leases - a crucial housing market indicator - must continue to fall next year. And the labor market must cool down, with wages falling to more sustainable levels.

“Despite some promising developments, we have a long way to go in restoring price stability,” Powell said.

Powell put particular emphasis on the labor market, which has been transformed by the pandemic in ways economists still struggle to understand. The number of job openings far exceeds the number of people looking for work, and Powell said that the shortfall in labor supply “appears unlikely to fully close anytime soon.” The Fed cannot bring more people back into the labor market, so its goal is to get borrowing costs high enough that businesses pull back on hiring and investing, thus cooling down demand for new workers.

But Powell said it would also be helpful if other policymakers - he didn’t name any, but the task could fall to Congress or the Biden administration - would help find ways to add workers to the labor force while the Fed focuses on demand for work.

“I will say that policies to support labor force participation could, over time, bring benefits to the workers who join the labor force and support overall economic growth,” Powell said, noting he was not advocating for any particular policies. “For the near term, a moderation of labor demand growth will be required to restore balance to the labor market.”

Plenty of other Fed officials - including board members and regional bank presidents - have weighed in on the economy and the path ahead in recent weeks, especially after an October inflation report came in much better than expected. But Powell has not spoken publicly since the Fed’s last policy meeting in early November, when he warned that it had become “harder to see the path” to avoiding a recession. Some Fed watchers speculate that Powell’s speech Wednesday was meant to reassure markets that while the Fed will slow its hikes, it has not yet regained control of inflation, which remains near 40-year highs despite signs of easing and affects nearly every part of Americans’ daily lives.

Powell is not scheduled to speak again in public until the Fed’s final policy meeting of the year in mid-December. The remarks on Wednesday, then, aimed to cement expectations for Wall Street and the broader public about what is still to come. The Fed has enormous power wrapped up in interest rate policy. But the central bank also depends heavily on messaging and communication - and on the chair’s ability to guide markets about what the Fed is doing.

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That is a difficult job in any time, and especially when the economy is as mystifying as it is today. To fill the gaps, officials will look closely at economic data being released this week. On Wednesday, a new government report showed the number of job openings ticked down in October, an encouraging sign for officials looking for signs that the labor market may be slowing. New inflation data covering October comes out Thursday, and the November jobs report comes out on Friday.

Still, those snapshots are unlikely to change the Fed’s likely plans to raise rates by half a percentage point in two weeks, marking the seventh rate hike in a historic year.

The central bank hiked rates by three-quarters of a percentage point at each of its last four meetings, moving at the most aggressive pace in decades. Since March, the Fed has lifted its policy rate from near zero to between 3.75 and 4%, and expectations are growing among Fed watchers and economists that rates could eclipse 5% next year. When officials convene in two weeks for their final meeting of the year, they will compile new economic projections likely showing rates stay higher for longer than previously expected - and that any rate cuts are still well off in the future.

That approach is difficult to get right. The Fed does not want to signal that smaller hikes mean officials are seeing enough progress on the inflation. And in a similar way, the Fed does not want the markets or Wall Street analysts to misinterpret an eventual pause in rate increases. Hikes operate with a lag, and it will take months for the full weight of the Fed’s decisions to seep through the economy. Sometime in 2023, the Fed’s goal will shift from raising rates to holding them at a sufficiently high level and letting the economy continue to slow - ideally, without contracting altogether.

Speaking to reporters earlier this month, Boston Fed President Susan Collins said took issue with the word “pause” to describe what would happen if the central bank stopped raising rates, since it could have misleading associations.

“Getting rates to a level where they’re sufficiently tight, and holding them there, is about resolve, because that does have an impact on the economy,” Collins said. “To me, that’s not a ‘pause.’”