Fed leader: Rate cuts likely, but more evidence needed that inflation is tamed

Chair Jerome Powell reinforced his belief Wednesday that the Federal Reserve will cut its key interest rate this year but that it first wants to see more evidence that inflation is falling sustainably back to the Fed’s 2% target.

Powell noted that inflation is slowing for both goods and services and did not express concern about the government’s latest inflation data, which showed some pickup in price increases in January. Instead, he said that, according to the Fed’s preferred gauge, inflation “has eased notably over the past year” even though it remains above the Fed’s target.

The Fed chair’s remarks, in testimony to a House committee, echoed the message he expressed at his most recent news conference on Jan. 31. At that time, he said the Fed’s interest-rate setting committee needed “greater confidence” that inflation was nearly in check before it would reduce its benchmark rate.

On the first of his two days of semi-annual testimony to Congress, Powell also suggested that the Fed faces two risks: Cutting rates too soon—which could “result in a reversal of progress” in reducing inflation—or cutting them “too late or too little,” which could weaken the economy and hiring.

The effort to balance those two risks marks a shift from early last year, when the Fed was still rapidly raising its benchmark rate to combat high inflation.

Later, in response to a question at the hearing, Powell said the Fed would alter a central bank proposal that would toughen bank regulation by requiring the 32 largest banks to hold additional capital—assets similar to cash—against potential lending losses. The biggest banks have criticized the proposal, released last summer, arguing that it would force the banks to reduce lending and slow the economy as a result.

“I do expect there will be broad and material changes to the proposal,” he said. “I’m confident that the final product will be one that does have broad support both at the Fed and in the broader world,” he added, acknowledging that some Fed officials opposed the proposal when it was first released.

Just before the hearing, Republicans on the House Financial Services Committee denounced the proposed rule and urged the Fed to withdraw it. Powell said the central bank would consider withdrawing it and re-issuing an amended version.

The financial markets are consumed with divining the timing of the Fed’s first cut to its benchmark rate, which stands at a 23-year high of about 5.4%. A rate reduction would likely lead, over time, to lower rates for mortgages, auto loans, credit cards and many business loans. Most analysts and investors expect a first rate cut in June, though May remains possible. Fed officials, after their meeting in December, projected that they would cut rates three times this year.

In his remarks Wednesday, Powell offered no hints on the potential timing of rate cuts. Wall Street traders put the likelihood of a rate cut in June at 69%, according to futures prices, up slightly from about 64% a week ago.

Powell also underscored that the Fed’s policymakers believe they are done raising rates, which are likely high enough to restrain the economy and inflation. He stressed that the Fed’s rapid rate hikes in 2022 and 2023 haven’t led to higher unemployment. And under questioning, he added that he foresees little chance of a recession, which a year ago was widely predicted by most economists.

“There’s no reason to think the U.S. economy is in some kind of short-term risk of falling into recession,” Powell said.

The Fed chair’s testimony to the House Financial Services Committee coincides with intensified efforts by the Biden administration to stem public frustration with inflation, which erupted three years ago and has left average prices well above where they were before. President Joe Biden’s bid for reelection will pivot in no small part on voter perceptions of his handling of inflation and the overall economy.

The administration is trying to crack down on what it calls unjustified price hikes by many large companies. Biden recently attacked “shrinkflation,” whereby a company shrinks the contents of a product rather than raise its price. The president has also sought to limit so-called “junk fees,” which in effect raise the prices that consumers pay.

Overall inflation has steadily cooled, having measured at just 2.4% in January compared with a year earlier, according to the Fed’s preferred gauge, down from a peak of 7.1% in 2022. Yet recent economic data have complicated the picture and clouded the outlook for rate cuts.