Fed may need more aggressive interest rate hikes, Powell says

WASHINGTON — Cooling in the economy appears to have “partly reversed” based on recent data on jobs, consumer spending, production and inflation, Federal Reserve Chair Jerome H. Powell told Congress on Tuesday, suggesting the central bank could keep raising interest rates more aggressively than expected just a few months ago.

“The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,” Powell told the Senate Banking Committee.

“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”

The remarks, given at the start of two days of testimony on Capitol Hill, underscore how quickly the economy continues to shift three years since the pandemic began.

They also mark a clear signal from the economy’s most powerful policymaker that the Fed would consider sharper interest rate hikes if officials felt the economy was moving in the wrong direction.

Fed leaders will convene again March 21 through 22, where they will announce their next rate hike and release a fresh set of economic projections on inflation, the unemployment rate, economic growth and the future path for the baseline interest rate controlled by the central bank control.

For much of last year, the Fed sprinted to catch up to inflation that soared to 40-year highs, hiking interest rates by 4.5 percentage points in less than a year.

Once rates were high enough to actively slow the economy, the Fed decided to slow its pace, scaling down from a half-point increase in December to a quarter-point in its first meeting of 2023.

The plan then was to stick to a few more quarter-point increases until pausing rate hikes altogether, so the full weight of the Fed’s decisions last year could work through the economy.

But in a matter of weeks, that plan has been cast into doubt by economists and Fed watchers, who point to a recent crop of hotter-than-expected data and argue the Fed might have to scale up once again.

If the Fed did scale back up to a half-point hike, central bankers would be going against many of their messages from the past few months.

Officials have argued that smaller, quarter-point increases give them more flexibility as they tiptoe up to the federal funds rate’s ultimate level.

Rate hikes also operate with long lags, and policymakers have warned about the risks of going too far, too fast, especially since the Fed has the dual responsibility of controlling prices and also supporting the labor market.

Fed leaders have consistently said they will make decisions based on all the data before them, and they typically don’t commit to specific moves weeks before a policy meeting.

But Powell’s remarks appeared to answer growing anxiety that the Fed risks falling behind in its inflation fight once again if it sticks to its previous plans of quarter-point hikes.

The Fed prefers to move slowly and deliberating, and policymakers aren’t easily swayed by one month of data.

But the COVID economy continues to defy expectations, leaving economists and policymakers to scrap their forecasts every few months.

Not long ago, Fed experts assumed that such whopping rate hikes would surely cause a recession in late 2022 or early 2023.

But now, fewer economists expect a downturn this year, especially if the job market and consumer spending remain strong.

Employers added a whopping 517,000 jobs in January, shattering expectations and upending impressions that the labor market was cooling.

In a shock to observers, the unemployment rate fell to 3.4%, a low not seen since May 1969.

Speaking at an event hosted by the Economic Club of Washington, D.C., last month, Powell said: “We didn’t expect it to be this strong, but it kind of shows you why we think that this will be a process that takes a significant period of time.”

Meanwhile, inflation has fallen from last summer’s peak but remains well above normal levels.

And the Fed’s inflation fight appears to be getting harder.

January prices eased over the year before, but only slightly, and the concern now is that the remaining sources of inflation will be more difficult to root out.

At the top of that list is inflation that stems from the hot labor market, which can be exacerbated by wage pressures and mismatches in the number of job openings vs. the number of people looking for work.

That has Fed officials focused on inflation in service industries like health care and hospitality.

A hot labor market is usually a boon for workers, giving them leverage and negotiating power for higher pay.

Yet Powell said that “strong wage growth is good for workers but only if it is not eroded by inflation.”

“We have more work to do,” Powell told lawmakers. “Our policy actions are guided by our dual mandate to promote maximum employment and stable prices. Without price stability, the economy does not work for anyone.”