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US Fed preparing to remove stimulus ‘soon’ despite slower recovery

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The Federal Reserve's stimulus policies have been credited with helping the US economy recover from the Covid-19 pandemic./AFP
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Sep 23, 2021 - 07:48 AM

WASHINGTON — Rising Covid-19 cases have slowed the US economy’s recovery, but the Federal Reserve on Wednesday said it may nonetheless “soon” be time to begin removing the stimulus it provided during the pandemic.

The closely-watched announcement left policy unchanged for now, but new forecasts from central bankers show they expect the first interest rate increase next year.

That would take the benchmark lending rate above zero in the world’s dominant economy for the first time since the start of the pandemic.

Market watchers, as well as inflation hawks at the Fed, are concerned the stimulus is fueling price increases, and Fed Chair Jerome Powell acknowledged that inflation could remain higher than expected as supply and employment constraints continue after last year’s widespread business closures.

When the pandemic hit in March 2020, the Fed slashed its benchmark interest rate and began buying bonds and other securities to ease lending conditions and ensure the financial system would not seize up.

Powell said the purchases served as a “critical tool” to support the economy and keep markets functioning, but their effectiveness has waned.

Now, the economy has healed to the point that the central bank could slow the pace of purchases “if progress continues broadly as expected,”  the policy setting the Federal Open Market Committee (FOMC) said in a statement after concluding its two-day meeting.

Raising rates sooner 

The Fed is juggling competing forces as rising prices fuel inflation concerns while the economy remains about five million jobs short of where it was before the pandemic struck, forcing widespread business closures.

Though Powell again stressed that the Fed will not increase the key borrowing rate until later, rising inflation makes it more likely the central bank will have to move sooner than expected.

In their quarterly forecasts, FOMC members boosted their inflation forecasts to a median of 4.2 percent for the year, even as they cut their 2021 growth outlook to just 5.9 percent from the seven percent projected in June.

More members of the committee now see the first interest rate hike next year, and as many as three in 2023.

The FOMC still attributes the recent price pressures to “transitory factors,” and Powell said he expects the supply effect to “abate,” allowing inflation “to drop back toward the longer run goal” of two percent.

But the Fed chief acknowledged there is an “upside risk,” due to supply challenges and the shortage of workers.

“As the reopening continues, bottlenecks, hiring difficulties and other constraints can prove to be greater and longer-lasting than anticipated,” he told reporters after the committee’s meeting.

But progress towards the Fed’s two percent inflation goal is “very much on track.”

Tapering comes first 

The Fed is currently buying at least $80 billion in Treasury securities and $40 billion in agency mortgage‑backed securities every month as part of its stimulus efforts.

Powell said if the economy continues to improve, “A gradual tapering process that concludes around the middle of next year is likely to be appropriate.”

Asked by AFP if inflation concerns could lead the Fed to start raising interest rates before it had completed the taper, Powell said that would not make sense.

“We can speed it up or slow it down as needed” and pull back faster if inflation is too high.

Analysts expect the taper to be announced at the FOMC’s next meeting in early November and begin in December, but Powell said some members would prefer to move sooner.

Diane Swonk of Grant Thornton said Powell is holding the line as “a dove among the hawks,” with forecasts suggesting more central bankers “are concerned inflation will become a larger problem in 2022.”

Still, despite the downshift in the pace of the US recovery, policymakers remain relatively optimistic about the outlook.

“The sectors most adversely affected by the pandemic have improved in recent months, but the rise in Covid-19 cases has slowed their recovery,” the FOMC statement said, stressing that the bounceback is dependent on the course of the pandemic.

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