Powell sends strong signal Fed could dial back stimulus this year

Jay Powell has sent his strongest signal yet that the Federal Reserve could start dialling back its massive pandemic-era stimulus programme this year, declaring the US central bank had met the first of two goals it wants to achieve before reducing its support and was making "clear progress" on the second.

In a closely watched virtual speech at the Jackson Hole gathering of central bankers on Friday, Powell emphasised the robust economic rebound from the depths of the coronavirus outbreak, and expressed confidence the world’s largest economy was on a path that will allow the central bank to begin withdrawing its support.

The central bank has been buying $120 billion (€102bn) of Treasuries and agency mortgage-backed securities each month since the outset of the coronavirus crisis last year, and has pledged to do so until it sees “substantial further progress” on its goals of average 2 per cent inflation and maximum employment.

“My view is that the ‘substantial further progress’ test has been met for inflation,” Mr Powell said on Friday. “There has also been clear progress toward maximum employment.”

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Minutes from the latest meeting on monetary policy indicated a majority of officials believe it would be appropriate to start “tapering” the bond-buying programme this year – a timeline that Powell endorsed on Friday.

His comments come at a highly uncertain moment for the world’s largest economy.

Policymakers and economists alike are scrambling to assess the potential economic damage from a startling surge in Covid-19 cases fuelled by the highly transmissible Delta strain, which abruptly disrupted the Kansas City Fed’s plans to host this year’s symposium in person.

Bond purchases

Conflicting economic signals have also made it difficult for central bankers to reach a consensus on when exactly the “tapering” process should begin, and at what point these bond purchases should cease altogether.

A growing cohort of central bank officials have pointed to surging US consumer prices, which have been propelled by widespread supply chain constraints, to build a case that the Fed should end these bond purchases soon if it wants to avoid even higher inflation and financial instability.

Mr Powell has previously acknowledged that inflationary pressures have mounted more quickly and by a larger magnitude than the Fed had initially forecast, and on Friday insisted the central bank would act if needed.

“If sustained higher inflation were to become a serious concern, the Federal Open Market Committee would certainly respond and use our tools to assure that inflation runs at levels that are consistent with our goal,” he said.

However, he warned against moving prematurely to tackle consumer prices, which the Fed believes to be “transitory” and are most pronounced in a narrow range of sectors sensitive to pandemic-related disruptions.

“If a central bank tightens policy in response to factors that turn out to be temporary, the main policy effects are likely to arrive after the need has passed,” he said.

“The ill-timed policy move unnecessarily slows hiring and other economic activity and pushes inflation lower than desired. Today, with substantial slack remaining in the labour market and the pandemic continuing, such a mistake could be particularly harmful.”

Announcement

His comments come as more “hawkish” members of the policymaking Federal Open Market Committee call for an announcement on tapering at the Fed’s September meeting. They have argued for an end to the programme by the second half of next year at the latest.

That would give the Fed the flexibility it needs to raise US interest rates in 2022 if inflation proves more persistent than initially anticipated. The Fed’s latest projections, published in June, indicate at least two rate increases are expected in 2023.

But with almost 6 million more Americans out of work than before the pandemic struck, and Covid concerns rising again, another faction of officials have argued that a more patient approach may still be appropriate.

Ahead of Mr Powell’s speech, most market participants believed an announcement was likely in November, with tapering beginning either in December or January. – Copyright The Financial Times Limited 2021