Fed’s Powell says policy is on track despite “uncertain” fallout from Ukraine war

The Federal Reserve is set to press ahead with its rate hike plans this month to try to tame high inflation, but the outbreak of war in Ukraine has made the outlook “highly uncertain” for Federal Reserve policymakers as they decide their next steps plan, Fed Chair Jerome Powell said on Wednesday.

In prepared remarks for his hearing before the US House Financial Services Committee, Mr. Powell reiterated the Fed’s core narrative that high inflation and an “extremely tight” labor market warrant higher interest rates.

“We believe it will be appropriate to raise the target range for the federal funds rate at our meeting later this month,” Powell said, and that the Fed could expect cuts to its roughly $8.5 trillion fund later this year. Dollar-heavy Treasury portfolios will follow.

But in his opening remarks to lawmakers, Powell gave no indication of how far or how fast the Fed would need to go in its policy tightening, saying Fed officials still expect inflation to ease later this year and framing the Beginning and ending his remarks with the events in Ukraine.

US stock index futures fell slightly after the release of Mr Powell’s prepared remarks, while the 2-year Treasury yield rose. The US dollar traded higher against a basket of major trading partner currencies.

“He preferred to keep the Fed’s options open…there was little resistance to current market interest rate expectations, which have fallen sharply since the Russian invasion,” said Paul Ashworth, chief US economist at Capital Economics.

The impact of the coronavirus pandemic on the economy seemed to be fading, Mr Powell said in his prepared remarks, recruitment remains strong and inflation has emerged as the main risk.

Inflation “is now well above our long-term target of 2%. Demand is strong, and shortages and supply constraints limit how quickly manufacturing can respond,” the Fed chair said. He added that these supply disruptions were “larger and more prolonged than expected” and reiterated the Fed’s pledge to do whatever it takes to bring prices back into line.

While some of these current inflationary pressures are expected to ease later this year, “we are alert to the risks of potential further upward pressures… We will use our policy tools appropriately to prevent higher inflation from taking hold.”

However, Mr Powell also acknowledged the new complexities facing the Fed due to events in Europe, which have the potential to increase price pressures but also potentially undermine growth.

“The near-term impact of the invasion of Ukraine, the ongoing war, sanctions and upcoming events on the US economy remains highly uncertain,” he said. “In order to conduct appropriate monetary policy in this environment, one has to recognize that the economy is developing in unexpected ways. We need to respond quickly to incoming data and the evolving outlook.”

effects of war

Persistently high inflation, now three times the Fed’s 2% target, has surprised policymakers, who thought the pandemic-triggered streak of rapid price hikes would prove temporary.

They have been discussing what to do about it since last fall.

The central bank is expected to make a statement at its monetary policy meeting on June 15-16. Further rate hikes are expected for the remainder of this year, steadily increasing the cost of borrowing for consumers and businesses.

While the Fed remains focused on high inflation, Russia’s invasion of Ukraine has added a new dimension to policymakers’ analysis, with the potential to steer monetary policy in opposite directions. Inflation can rise even further, for example due to rising energy prices and new restrictions on the movement of people and goods.

But global economic growth could take a hit just as US and European governments had hoped the pandemic would subside enough to lift final restrictions on businesses, schools and socializing.

Should the war in Ukraine continue or even escalate into a larger conflict, the Fed could be called upon to keep global dollar markets stable, a task that could conflict with plans to reduce its asset holdings.

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