Fed to begin slowing economic aid as inflation worries increase

WASHINGTON — The Federal Reserve will begin dialing back the extraordinary stimulus it’s provided since the pandemic erupted last year, a response to an improving economy and escalating concern that high inflation now looks likely to persist longer than it did just a few months ago.

In a statement Wednesday after its latest policy meeting, the Fed said it will keep interest rates near zero but start reducing its $120 billion in monthly bond purchases in the coming weeks, by $15 billion a month. Those purchases have been intended to hold down long-term interest rates to spur borrowing and spending. With the economy recovering, that’s no longer needed.

The Fed’s announcement comes against backdrop of surging prices across the economy – in food, rent, heating oil, autos and other necessities – that have imposed a burden on households and have become a political liability for the Biden administration and its Democratic allies in Congress.

At a news conference, Chair Jerome Powell acknowledged “the difficulties that high inflation poses for individuals and families.” At the same time, he stressed that the unusual uncertainties created by a brutal but brief recession and the robust recovery that quickly followed have made it difficult for the Fed to foresee the direction of inflation and the overall economy.

“We’re learning now we have to be humble about what we know about this economy,” the Fed chair said.

For that reason, Powell sees no reason for the Fed to raise its benchmark short-term rate from its ultra-low level anytime soon. That key rate influences many consumer and business loans. Until the delta variant’s impact on the economy has fully passed, he said, the job market won’t likely fully recover and many supply chains will remain snarled.

The central bank is in the process of shifting from an effort to boost the economy and encourage more hiring to one that is focused on rising inflation. Prices jumped in September from a year earlier at the fastest pace in three decades. The Fed now faces the delicate task of winding down its ultra-low-rate policies, which it hopes will slow inflation, without doing it so rapidly as to weaken the job market or even cause another recession.

“The Fed clearly does not think that inflation is likely to stay at or near current levels, nor does it think that the labor market is back to full employment,” said Eric Winograd, an economist at the asset manager AllianceBernstein. “Until they become convinced either that inflation is durably too high, that inflation expectations have become unanchored or that the economy is at full employment, they do not intend to raise interest rates.”

The central bank will slow its $80 billion in Treasury purchases by $10 billion a month and its $40 billion in mortgage bonds by $5 billion in November and December and said similar reductions “will likely be appropriate” in the following months. Its statement noted that it would adjust the pace of the reductions “if warranted by changes in the economic outlook.” That suggested that the Fed might decide to accelerate its pullback in bond buying if inflation worsens.

If the pace is maintained, the bond purchases would end altogether in June. At that point, the Fed could decide to raise its benchmark short-term interest rate, which affects many consumer and business loans. That would be much earlier than Fed officials had envisioned last summer, when they collectively forecast that the first rate hike wouldn’t happen until late 2023.

According to the Chicago Mercantile Exchange’s FedWatch tool, market traders now expect at least two rate hikes during 2022.

In recent public remarks, Powell has acknowledged that inflation has endured longer than expected and that risks of higher prices remain. The Fed’s latest statement said that officials still regard shortages of materials and labor as the main factors raising inflation. Powell suggested Wednesday that those factors would ease over time, though perhaps not until the middle of next year.

So far, the Fed chair added, recent pay gains that have gone to many Americans do not appear to have intensified inflation – something that can happen if companies seek to offset their higher labor costs by raising prices.

“We don’t see troubling increases in wages,” Powell said.

The economy has steadily recovered from the pandemic recession, although growth and hiring stumbled in the July-September quarter, partly because a surge in delta cases discouraged many people from traveling, shopping and eating out. Many economists say they’re hopeful that with vaccinations increasing and the delta wave fading, job growth rebounded in October from September’s weak pace. The October jobs report will be released Friday.

Last week, the government reported that prices surged 4.4% in September from a year earlier – the fastest 12-month increase since 1991. Yet while inflation is running hot, the job market isn’t back to full strength. The unemployment rate was 4.8% in September, above its pre-pandemic level of 3.5%. And roughly 5 million fewer people have jobs now than did before the pandemic.

That puts Fed officials, particularly Powell, in a bind: They might want to keep their benchmark short-term interest rate at nearly zero, where it has been pegged since last March, to boost the economy and encourage more hiring. But they are facing growing pressure, including from Republican lawmakers in Congress, to rein in rising prices, which are offsetting much of the benefit that many Americans have enjoyed from recent wage increases.

Wages and salaries soared in the July-September period by the most in at least 20 years. That suggested that workers are increasingly able to compel higher pay from businesses that are desperate to fill a near-record number of open jobs. But the gain was largely offset by rising inflation.

The Fed’s meeting occurred as Powell’s future as Fed chair remains uncertain. President Joe Biden has yet to announce whether he will re-nominate Powell for another four-year term. Powell’s current term expires in early February, but previous presidents have usually announced such decisions in the late summer or early fall.