The Fed assesses the prospects for further rate hikes

Fed Chairman Jerome Powell, speaking at an economic policy symposium in Jackson Hole, said that the regulator is ready to continue raising rates to fight inflation, but will build on new data. At the same time, Mr. Powell explained in more detail than usual the essence of the difficulties faced by the Fed and which explain the uncertainty in the regulator’s signals. First of all, this is the growing influence of the labor market on inflation, as well as the impossibility of accurately determining the level of the “neutral” rate, in comparison with which one can assess the rigidity of monetary policy. With continued high consumer demand and low unemployment, the Fed could see a rare soft slowdown in the coming months, although in a classic scenario, fighting inflation is impossible without a tangible decrease in activity.

The Fed could raise rates again if needed and tighten monetary policy until it is confident that inflation will fall steadily, Fed chief Jerome Powell said at the Jackson Hole Banking Symposium, a key annual regulator-backed event. The markets took the signal of the head of the Fed as moderately harsh – this corresponds to a decrease in interest in risky assets and the strengthening of the US dollar against the currencies of developing countries (including the ruble). At subsequent meetings (in September, November and December), the Fed will “move with caution” and take into account incoming data, the head of the regulator explained.

Inflation in the US has already slowed to 3.3% in July (the peak was in June 2022, when price growth accelerated to 7% in annual terms).

But this slowdown, according to the FRS, is not enough, since it is caused by a decrease in energy and food prices, which depend on the world market conditions – they can distort the real dynamics of price growth. The Fed prefers to build on core (excluding food and energy prices) inflation, which slowed to 4.3% in July. In particular, the consumer spending deflator, which the Fed is guided by, showed an increase of 4.1% in June (4.6% in May), while if prices for goods grew by 0.6% year-on-year, then for services – by 4.9% (at the same time, food prices rose by 4.6%, while energy prices fell by 18.9%).

The slowdown in inflation was affected both by the weakening of post-pandemic demand and the removal of restrictions on the supply side (in particular, the reduction in the cost of shipping by sea and the elimination of the shortage of goods and components), as well as the tightening of monetary policy, which puts pressure on demand (the effect is especially noticeable in the real estate market). But the fight against inflation is “far from over” – the Fed cannot yet assess either the sustainability of this trend or the degree of a possible reduction in inflation, Jerome Powell explained. Services (excluding rent) account for half of the increase in core inflation – the decline here is slower, as it is less dependent on both the global environment and the level of Fed rates. The labor market, on the contrary, affects the cost of services more strongly. In the future, the contribution of rate hikes to slowing inflation will increase, the Fed expects.

The rise in rates, however, does not slow down the economy as expected, which is also confirmed by higher growth in consumer activity (even the real estate market shows signs of improvement after 18 months of decline). The main “problem” remains the state of the labor market – the influx of labor (both due to an increase in the proportion of workers and through migration) is accompanied by some slowdown in demand and a decrease in pressure on real incomes – they continue to grow against the backdrop of a slowdown in inflation. A signal of increased imbalance in the labor market could lead to further tightening of monetary policy, the head of the Fed explained.

The task of determining the degree of tightening needed for the Fed, however, has become more difficult: real rates are now higher than most neutral estimates (have neither stimulating nor inhibitory effect on the economy), but it is not possible to determine the neutral level exactly, so there is always uncertainty about what there must be a bet to have the desired effect. Additional complexity is also created by the lags with which monetary tightening operates. The most urgent problem for the Fed is to assess the impact of the state of the labor market on inflation – the relationship has become stronger than in previous decades, the head of the American regulator stated.

Tatyana Edovina