Fed signals it may reduce bond-buying stimulus by year-end, forecasts first rate hike next year amid higher inflation, slower growth

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The Federal Reserve is wrestling with how to continue getting Americans back to work after the historic COVID-19-induced downturn while guarding against a persistent surge in inflation.

It’s a delicate balance.

Citing an outlook for faster inflation but slower economic growth than it previously forecast, the Federal Reserve on Wednesday signaled plans to begin tapering its bond buying stimulus by year’s end and possibly raise interest rates in 2022, a year earlier than it had anticipated.

The central bank is buying $120 billion a month in Treasury bonds and mortgage-backed securities to hold down long-term rates. It reiterated it will continue the purchases at that pace “until substantial further progress has been made toward” the Fed’s goals of full employment and 2% inflation.

For a second straight meeting, the Fed said the economy “has made progress toward these goals.”

And in its statement after a two-day meeting, Fed officials said, “If progress continues broadly as expected (toward the Fed’s employment and inflation goals), the Committee judges that a moderation in the pace of asset purchases may soon be warranted.”

At a news conference, Fed Chair Jerome Powell said the central bank could well announce that it will start cutting back the market-friendly bond purchases at its next meeting in early November.

"We could easily move ahead at the next meeting, or not, depending on whether those tests are met," Powell said. He added that the economy has already met its goal of nudging persistently low inflation higher, with annual consumer price increases running well above the Fed's 2% goal for several months. The unemployment rate, which has fallen to 5.2% from 6.7% at the end of last year, is about halfway toward the Fed's target, he said,

Perhaps the most critical measure the Fed will be watching is the September employment report, due in early October, after August job gains were disappointing.

"It wouldn't take a knockout, super-strong employment report" to start cutting the bond buying, he said. "It would take really a good enough report."

Ian Shepherdson, chief economist of Pantheon Macroeconomics, expects the Fed to start scaling back the purchases in November, unless Congress fails to resolve its standoff over raising the government’s debt ceiling, or borrowing authority. Under that scenario, Powell said he expects the purchases to conclude by the middle of next year.

The Fed launched the bond buying at the start of the pandemic to prevent Treasury and mortgage markets from freezing up amid investor panic, and then to push down long-term interest rates.

"Now we're in a situation where they still have a use but their usefulness is much less, as a tool," Powell said.

The Fed left its key short-term rate near zero but projected it could modestly raise it next year to about 0.3% and it will end 2023 at about 1%, above its June forecast of 0.5% to 0.75%, according to officials’ median estimate.

Nine Fed of 18 Fed policymakers now predict at least one rate hike next year, up from seven in June, a split that indicates the Fed could raise the rate by about half of the quarter point increase that is typical. And the officials now foresee three hikes in 2023, up from two in June, and two more in 2024.

Fed officials predict the economy will grow a still-robust 5.9% this year, but that’s down from their 7% estimate in June. They forecast 3.8% growth in 2022, up from 3.3% in their previous projection. They estimate unemployment will fall from 5.2% to 4.8% by year-end, higher than their prior 4.5% forecast.

But inflation has been heating up more than expected. The Fed believes its preferred measure of annual inflation will end 2021 at 4.2%, up from its 3.4% estimate in June. A core inflation measure that strips out volatile food and energy items is projected to close the year at 3.7%, up from its 3% estimate. Still, officials expect overall and core inflation to fall to 2.2% and 2.3%, respectively, by the end of next year. l

The Fed also repeated Wednesday it would keep its benchmark short-term rate near zero until the economy returns to full employment and inflation has risen above its 2% target “for some time.”

At the Fed's annual conference in Jackson Hole, Wyoming, Powell took pains to emphasize that scaling back the bond-buying would not necessarily foreshadow rate hikes shortly after, noting the stricter criteria for lifting rates. But economists have said Powell would face challenges assuring markets of that distinction if Fed policymakers moved up their rate hike forecasts, as they did Wednesday.

Fed officials are grappling with how to respond to an economy that has slowed recently even as inflation has picked up more sharply than expected.

Typically, stronger growth spurs faster inflation, prompting the Fed to raise rates to head off a spike in prices that could derail an economic expansion. It lowers rates to jolt weak growth, which is typically accompanied by modest inflation.

Growth is still expected to be historically strong this year as consumers have resumed traveling, shopping and dining out in greater numbers. But activity has sputtered recently amid a surge in COVID cases triggered by the delta variant.

The economy also has been crimped by worker shortages and related supply-chain bottlenecks that have hampered the delivery of a broad range of goods and services. The worker crunch was expected to ease in September as schools reopened, allowing parents to return to workplaces, while enhanced unemployment benefits expired early this month, likely prodding some Americans to intensify their job hunts.

The COVID surge, however, has placed a speed bump in the nation’s return to normal life. Just 235,000 jobs were added in August, down from an average 876,000 from May through July. Some economists believe the soft patch is temporary, noting COVID cases already appear to have peaked now that more people are getting vaccine shots and worker shortages and supply snarls should soon ease.

Sixty-six percent of U.S. adults have been fully vaccinated, according to the Centers for Disease Control and Prevention, though the total has crept up slowly in recent months.

At the same time, the worker shortages have sparked higher wages for restaurant and other employees, pushing up consumer prices. The supply snarls similarly have led to product shortages and higher prices. The Fed’s preferred inflation measure reached 4.2% in July, well above its 2% target, and the core reading hit 3.6%.

Powell, like other Fed officials, has said he believe the spike is largely rooted in price surges for COVID-related products and services – such as used cars, hotel rates and air fares – that already have started to pull back. That group wants to keep rates lower for longer to ensure unemployment can return close to the 3.5% pre-pandemic level that marked a 50-year low.

But other Fed policymakers fear the worker shortages and supply strains could prove more enduring and want to get ahead of a longer-lasting inflation surge by raising rates sooner.

This article originally appeared on USA TODAY: Federal Reserve: Fed signals it will taper bond purchases this year

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