U.S. inflation is easing again after a sharp rise earlier this year, according to Federal Reserve Chairman Jerome Powell. But Powell stressed on Tuesday that the Fed needs more evidence before considering cutting interest rates. The caution underscores the complexity of monetary policy in the current economic environment.
Fed not ready to cut interest rates despite slowing inflation
Powell noted that the April and May data point to a return to deflationary trends after persistently high inflation at the start of 2024. Speaking at the European Central Bank's monetary policy conference in Sintra, Portugal, Powell said Fed officials would like to see annual price growth fall further toward their 2% target so that high inflation can be fully resolved.
“We need to make sure that current levels truly reflect underlying inflation,” Powell said. The need for that check underscores the Fed's cautious approach to adjusting policy.
A delicate balance
Chairman Powell acknowledged that the Fed must strike a delicate balance in deciding when to cut its benchmark interest rate. The Fed's benchmark interest rate was raised 11 times between March 2022 and July 2023, to 5.3%. Those hikes were intended to combat the worst inflation in four decades by reducing consumer and business borrowing and spending. Inflation has fallen from its 2022 peak but remains high, posing an ongoing challenge for policymakers.
Powell has warned that cutting rates prematurely could lead to a resurgence of inflation, necessitating further rate hikes. Conversely, delaying rate cuts for too long could weaken the economy too much and risk a recession. Striking that balance is a major concern for Powell and his colleagues at the Fed.
“Striking the right balance for monetary policy at this critical time is something I think about a lot,” Powell said when asked about his main concerns, a comment that reflects the larger risks to the Fed's decision-making process.
Recent economic data
Consumer prices, the Fed's preferred measure, were flat from April to May, marking the slowest increase in more than four years, according to a recent government report. On a year-over-year basis, inflation fell to 2.6% in May from 2.7% in April. Excluding volatile food and energy prices, core prices rose slightly from April to May, with the core inflation rate falling to 2.6% from 2.8% in April. These figures are a significant improvement from the start of the year and provide some optimism about the Fed's efforts to contain inflation.
Powell said the U.S. economy and job market are fundamentally strong, allowing the Fed to consider the timing of a rate cut. Most economists expect the Fed's first rate cut to come in September, with possibly one more by the end of the year. But Powell's cautious tone suggests any such move would depend on a continuation of favorable data.
Labor Market Trends
The Fed chairman also noted that the job market is “moderately cooling,” suggesting that inflationary pressures are not likely to worsen due to sharp wage increases. This cooling is seen as a positive development because it reduces the risk of wage-led inflation.
“The job market does not appear to be overheating and no significant inflation risks are emerging,” Powell said. “The job market is cooling over time, as we would like it to.” This view is consistent with the Fed's broader goal of achieving a sustainable balance between economic growth and containing inflation.
Chairman Powell did not say when rates might be cut, leaving the timing undecided. Investors rate a rate cut at the September Fed meeting as nearly 70% likely, but that is by no means a certainty. The Fed's decision will likely be influenced by upcoming economic data and changing market conditions.
Diverging Views Within the Fed
Since the Fed last met more than two weeks ago, officials have offered mixed views on inflation and interest rate policy. New York Federal Reserve Bank President John Williams expressed confidence that the central bank can sustainably achieve its 2% inflation target, while San Francisco Fed President Mary Daly signaled uncertainty about whether the central bank is on track to achieve price stability.
The differing views within the Fed highlight the challenges of navigating the current economic climate, and the range of opinions reflects the complexity of interpreting economic data and deciding on forward-looking policy.
An international perspective
In Portugal, Powell participated in a panel discussion with European Central Bank President Christine Lagarde and Brazilian Central Bank President Roberto Campos Neto. This international context highlights the global nature of monetary policy challenges and the interconnectedness of economies.
The ECB has already cut interest rates by a quarter of a percentage point this year, as inflation in the 20-nation euro zone has fallen from more than 10% to just 2.5%. Nevertheless, Lagarde reiterated that the ECB is not on a “predetermined path” and that the latest cuts will be followed by further data considerations. Analysts speculate that the ECB's next rate cut may not come until September at the earliest.
These comments from global central bank leaders highlight the shared challenges and uncertainties facing policymakers around the world. The Fed and ECB's cautious approaches reflect a broader trend of caution in the face of uncertain economic conditions.
In summary, Chairman Powell's comments underscore his cautious optimism about the state of inflation in the United States while acknowledging the complexities and risks involved in adjusting monetary policy. The Fed's cautious approach seeks to balance the need for economic stability with its goal of returning inflation to its target level.
See also: