The U.S. Federal Reserve faces a cooling labor market as well as persistently high prices, Chairman Jerome Powell said in testimony before the U.S. Congress, a shift in emphasis from the Fed's sole fight against inflation of the past two years that suggests it is moving closer to cutting interest rates.
The Fed has made “considerable progress” toward its goal of defeating the worst inflation spike in four decades, Powell told the Senate Banking Committee on Tuesday.
“Inflation has slowed noticeably” over the past two years, he added, although it still remains above the central bank's 2 percent target.
Powell stressed that “high inflation is not the only risk we face.” Cutting interest rates “too late or too little could unduly weaken economic activity and employment,” he said.
The Federal Reserve chairman addressed the Senate panel in the first of two days of semiannual testimony before Congress. On Wednesday, he will testify before the House Financial Services Committee.
Between March 2022 and July 2023, the Federal Reserve raised its benchmark interest rate 11 times to a two-decade high of 5.3 percent to combat inflation, which peaked at 9.1 percent two years ago. Those hikes raised the cost of consumer credit by raising rates on mortgages, auto loans and credit cards, among other forms of borrowing. The goal was to curb borrowing and spending and cool the economy.
On Tuesday, Powell noted that inflation reports covering the first three months of this year did not boost Fed officials' confidence that inflation was under control.
“However, the most recent inflation readings have shown modest further progress,” Powell told the Senate committee, adding that “further positive data would strengthen our confidence that inflation is moving sustainably toward 2 percent.”
Gregory Daco, chief economist at consultancy EY, said he thought Powell’s “increased focus on bilateral risks to the outlook is positive, if a bit late.” Daco added that he thought the Fed should cut its benchmark rate at its July meeting. Otherwise, businesses could soon step up layoffs as the economy slows, he said.
Labor market slowing down
In the past, Powell and other Fed policymakers have repeatedly stressed that the strength of the U.S. economy and low unemployment rate meant they could be patient in cutting rates and wait to make sure inflation was truly under control.
But on Tuesday, Powell said the labor market has “cooled considerably,” adding that the economy’s growth has moderated after a strong expansion in the second half of last year. Last week, the government reported that hiring remained solid in June, although the unemployment rate rose for a third straight month to 4.1 percent.
The labor market “is not a source of broad inflationary pressures on the economy,” the Fed chairman said under questioning.
Powell did not give away what Wall Street investors are watching most closely: any clear indication of when the Fed might make its first rate cut. But his testimony will likely strengthen investors' and economists' expectations that the first reduction will come at the central bank's September meeting.
“The next step in monetary policy does not seem likely to be a rate hike,” Powell said in response to a question from Rhode Island Democratic Sen. Jack Reed. “As we make progress in combating inflation … we begin to ease monetary policy at the appropriate time.”
An independent institution
Powell also told senators that the Fed and other financial regulators will renew a proposal from last year that would have significantly increased the amount of capital banks would be required to hold to offset potential losses. The proposal was strongly opposed by the largest U.S. banks. They argued that the stricter capital requirements would have forced them to cut back on lending to consumers and businesses.
In his testimony, Powell also stressed the Fed’s independent character, which he said “is necessary to take a longer-term view” on interest rate policy and inflation. Raising borrowing costs to try to curb rising prices is often politically unpopular, and economists have long believed that central banks need to be insulated from political pressure to allow them to take such actions.
“One gets the sense that the Fed is setting a precedent ahead of the next presidential election,” said Joe Brusuelas, an economist at tax advisory firm RSM.
During his presidency, Donald Trump, in a highly unusual attack for a sitting US president, repeatedly denounced Powell, whom he had nominated to be Federal Reserve chairman, for raising interest rates. Trump has already indicated that he would not re-nominate Powell if elected president again.
On Thursday, the government will publish the latest reading of the well-known consumer price index. The CPI is expected to show an annual increase of just 3.1 percent in June, down from 3.3 percent in May.
These signs of slowing inflation, along with evidence that the economy and labor market are slowing, have intensified calls for the Fed to cut its benchmark rate. Several Democratic senators, including Sherrod Brown of Ohio, the chairman of the Senate Banking Committee, and Elizabeth Warren of Massachusetts, have written letters to Powell urging him to begin cutting rates.
