Federal Reserve Officials Warn Entrenched Inflation Poses ‘Significant Risk’

sCourtesy of Colby Smith, Financial Times

Minutes from June meeting suggest even tighter monetary policy may be needed from US central bank.

Top Federal Reserve officials think entrenched inflation is a “significant risk” to the US economy and fear tighter monetary policy will be needed if price growth exceeds their expectations, according to an account of their most recent meeting. The minutes of the US central bank’s June meeting, when the Fed delivered the first 0.75 percentage point rate rise since 1994, also showed that policymakers now support raising interest rates to the point at which economic activity is restrained, with the possibility that they could become “even more restrictive” if warranted by the data.

“Many participants judged that a significant risk now facing the committee was that elevated inflation could become entrenched if the public began to question the resolve of the committee to adjust the stance of policy as warranted,” the minutes said.

The notes from the Federal Open Market Committee, which were released on Wednesday, revealed the alarm spreading through the top ranks of the US central bank over inflation, which is running at an annual pace of 8.6 percent. The account also showed the lengths officials were willing to go to ensure prices do not spiral also showed the lengths officials were willing to go to ensure prices do not spiral further out of control.

The Fed will decide whether to raise rates by 0.50 percentage points or 0.75 percentage points at its meeting this month, although several officials have indicated their support for the larger increase.

“If inflation becomes entrenched in consumer and business psyches, it will be much more difficult to lower it over the medium term,” said Kathy Bostjancic, chief US economist at Oxford Economics. “That is the breaking point for [the Fed], and they really want to do their best to ensure that it doesn’t happen.”

She added: “The longer inflation remains high, the more it will become embedded in expectations.”The minutes showed that participants were increasingly aware that their plans to tighten monetary policy would slow the pace of economic growth. Most noted that the risks to the outlook were “skewed to the downside” given the possibility that further tightening could weigh on activity.

The minutes echoed recent comments from Fed chair Jay Powell, who has emphasized that the central bank has little room for maneuver as it tries to tame inflation without causing widespread job losses.

A US recession is now “certainly a possibility”, and would in large part depend on factors outside of the Fed’s control, he said last month, pointing to the war in Ukraine and prolonged Covid-19 lockdowns in China.

Powell reiterated that message last week on a panel with other central bankers, when he warned that a failure to restore price stability would lead to an even worse outcome for the US economy.

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