Fed prepares to stiffen inflation response for a post-transitory world

Washington - Instead of easing over 2021, as Fed officials expected, the pace of price increases has remained near levels not seen since the inflation scares of the late 1970s and early 1980s

The Federal Reserve is expected on Wednesday to announce that it is speeding up the end of its pandemic-era bond purchases, and signal a turn to interest rate increases next year as a guard against surging inflation.

The identification of the Omicron coronavirus variant last month has added a new level of uncertainty for US central bank officials who, after steadily discounting the impact of the pandemic on the economy’s performance, must now assess how the new strain’s faster spread may influence consumers, businesses, and the path of growth and inflation.

Private forecasters polled by Reuters still expect US growth of nearly four per cent next year, well above trend, and are aligned around expectations the Fed’s increased concern about inflation will cause it to pull the plug on the bond-buying program – originally set at $120 billion per month – in March and pencil in multiple rate increases for 2022.

The Fed will issue a new policy statement along with updated economic projections following the end of its latest two-day meeting. Fed Chair Jerome Powell will hold a news conference half an hour later.

Despite the unknowns around Omicron, the US unemployment and inflation rates have blown past the Fed’s most recent projections, issued in September, and policymakers now have to catch up with where the economy and markets seem to be heading.

The policymakers’ new forecasts “will generally show lower projections for the unemployment rate and higher ones for inflation,” prompting quarter-percentage-point increases in the Fed’s short-term policy rate beginning in June, JPMorgan economist Michael Feroli wrote in a note ahead of the meeting.

“We think it’s a close call between looking for two or three hikes in ’22, but think three is a little more likely,” Feroli wrote.

Powell’s news conference will draw particular attention for how the newly renominated Annual US inflation is currently running at more than double the Fed’s flexible two per cent target Fed chief frames the policy decision, the risks, and the outlook for next year, and whether his tone suggests more of an elevated concern about inflation, or the potential impact of the Omicron variant.

Either way there may be substantial change in the central bank’s policy statement. Powell hinted as much in recent testimony in Congress when he said it was “time to retire” the Fed’s reference to inflation as “transitory.”

Instead of easing over 2021, as Fed officials expected, the pace of price increases has remained near levels not seen since the inflation scares of the late 1970s and early 1980s, and gone on long enough that it has begun to depress consumer sentiment, undermine wage increases, and draw fire from politicians in both major political parties.

It has also arguably passed the test the Fed set in September of 2020 when it promised not to raise interest rates until inflation exceeded two per cent and was on track to remain above two per cent “for some time.”

Reuters