Jay Powell warns that the Fed is prepared to return to larger interest rate hikes

Jay Powell warned that the US Federal Reserve is prepared to return to bigger interest rate hikes to fight inflation in a congressional appearance on Tuesday.

In his first public intervention since data releases showed the central bank was struggling to cool the US economy despite a year-long campaign of monetary tightening, the Fed chair signaled his willingness to ramp up interest rate hikes to combat persistent price rises.

Powell told the Senate Banking Committee that “the ultimate level of interest rates is likely to be higher than previously expected” and said the latest economic data was “stronger than expected”.

He added: “Should all the data indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”

The Fed chair’s remarks led to a sell-off on the stock market, with the S&P 500 falling almost 1 percent. late in the morning in New York, while the Nasdaq fell 0.84 percent. The two-year government yield, which follows market expectations, rose to the highest level since 2007. The dollar rose 1 percent. against the euro on the day to 1.0572 dollars.

Traders increased their bets on a half-point increase at the Fed’s meeting on 21-22. March, with the odds now favoring such an increase over a quarter-point increase, according to CME Group.

The central bank has reduced the size of its rate hikes from 0.75 percentage points between June and November to a half point increase in December. It switched again in February to a more traditional quarter-point increase.

The Fed’s main interest rate is now at a target between 4.5 percent and 4.75 percent, compared to near zero at this time last year. In December, Fed officials expected interest rates to peak at 5.1 percent this year.

But Powell’s comments signal that he is willing to squeeze the economy further to bring down inflation.

His hawkish rhetoric is in line with comments by Christine Lagarde, president of the European Central Bank, who warned at the weekend that price pressures were “sticky”, requiring further action to tackle the inflation “monster”. The financial markets now expect the European interest rate to rise from 2.5 per cent. to over 4 per cent.

By contrast, Andrew Bailey, the Governor of the Bank of England, has been careful not to provide a precise guide to UK interest rates.

Two critical data releases due before the Fed’s meeting this month will help inform its next decision on rates: the monthly jobs report on Friday and the consumer price index report for February, due next week.

Investors and economists will be looking to see if the recovery in the labor market and consumer demand in January was sustained last month. Powell said the warm data “likely reflects the unusually warm weather” but also indicates “inflationary pressures are running higher than expected”.

Democrats have grown increasingly concerned that the Fed will go too far in tightening monetary policy, triggering a recession that could undermine many of the labor market gains made during the recovery from the coronavirus pandemic. But Powell maintained that getting core inflation to the Fed’s 2 percent target from January’s level of 4.7 percent would “very likely” require “some softening of labor market conditions,” suggesting job losses ahead.

“We cannot risk undermining one of the successes with our current economy,” said Sherrod Brown, chairman of the Senate Banking Committee.

Elizabeth Warren, the progressive Democrat from Massachusetts, accused Powell of “playing with people’s lives”.

Asked by Warren whether Americans at risk of losing their jobs should just “bear it,” Powell replied: “Will working people be better off if we just walk away from our jobs and inflation stays above 6 percent?”

He added that the “social cost of failure” on inflation was “very, very high” and warned of the risk of the “psychology” of “self-sustaining” inflation.

In a separate exchange with John Kennedy, the Republican senator from Tennessee, Powell rejected the idea that cutting inflation would push unemployment above 10 percent.

Instead, he said the Fed saw a “path” to bring inflation under control “with less significant effects on the labor market.”

Powell also faced questions about banking regulation, with Democrats pushing the Fed to tighten capital standards for the largest institutions and Republicans asking for looser treatment. Michael Barr, the Fed’s vice chairman for supervision, is leading a review of capital rules.

Additional reporting by Tommy Stubbington and Chris Giles

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