The US economy remains strong, but a series of aggressive rate hikes to cool rising inflation could eventually trigger a recession, Federal Reserve Chair Jerome Powell warned on Wednesday.
Powell, whose testimony before senators was closely watched by investors and analysts, also said the world’s largest economy was facing an “uncertain” global environment and could see more inflation “surprises.”
The Fed Chair reiterated that policymakers understand the difficulties raised by rising prices and are determined to bring inflation down, which has hit a 40-year high.
Last week, the Federal Reserve announced the biggest interest rate hike in nearly 30 years and pledged more similar steps to combat price hikes as gas and food costs soar and millions of Americans struggle to make ends meet.
But when Powell was peppered with questions about the prospect of a recession, he acknowledged the risk.
“It’s not at all our intended outcome, but it’s certainly a possibility,” he told the Senate Banking Committee.
“And frankly, the events of the last few months around the world have made it harder for us to achieve what we want, which is 2 percent inflation and a still strong labor market.”
In his opening remarks, Powell insisted that the US economy is “very strong and well positioned to deal with tighter monetary policy.”
“Inflation has obviously surprised on the upside over the past year, and more surprises could be in store for us,” the Fed chairman said in his semi-annual appearance before Congress.
Policymakers “have to be nimble” as the economy “often develops in unexpected ways,” he said.
The Fed has faced criticism for being too slow to respond to a changing economy, which has benefited from a spate of federal government stimulus packages.
Last week’s outrageous 0.75 percentage point hike in interest rates was the third since March, bringing interest rates up a total of 1.5 points. Powell said at the time a similar surge was likely in July.
The ideal scenario would be that these measures cool the economy enough to dampen inflationary pressures without stifling growth – the hoped-for soft landing.
“I think it’s going to be very challenging,” Powell said, insisting there are “ways” to avoid a recession and that he doesn’t see the risk of a downturn as “particularly high.”
Financial markets seemed cheered by his relatively dovish comments, in line with those of other Fed officials over the past few days who have balked at mounting pessimism.
But Wall Street shares lost steam towards the end of the trading session, and the Dow ended the day down 0.2 percent.
– “Indispensable” to curb inflation –
In addition to providing financial relief to less affluent American families, the Fed chair said containing inflation is “essential” to maintaining a healthy labor market.
The US economy recovered quickly from the Covid-19 pandemic, helped by robust consumer spending, and has continued to create jobs at a fast pace, taking unemployment down to nearly a 50-year low.
But buoyant demand for homes, cars and other goods has met transport and supply chain snarls in parts of the world where Covid-19 has remained a challenge.
That fueled inflation, which worsened dramatically after Russia invaded Ukraine in late February and Western nations imposed tough sanctions on Moscow, sending food and fuel prices skyrocketing.
But Powell noted that inflation is a global problem, not just in the United States.
Many major central banks have joined the Fed and begun tightening monetary policy – with the notable exception of the Bank of Japan.
Powell said many factors driving inflation are beyond the Fed’s control, but he pointed to signs that rising interest rates are having an impact, as business investment slows and “residential activity appears to be slowing, partly reflecting higher attributable to mortgage interest”.
According to Freddie Mac, average home equity interest rates on a 30-year fixed-rate mortgage rose in May to 5.23 percent from 4.98 percent in April, while the median home price surpassed $400,000 for the first time.
“The tightening financial conditions we’ve seen in recent months should further dampen growth and help demand better match supply,” Powell said.
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