Fed officials warn entrenched inflation poses ‘significant risk’

Top Federal Reserve officials have concluded entrenched inflation poses a “significant risk” to the US economy and fear even 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 June meeting, at which the Fed delivered the first 0.75 percentage point rate rise since 1994, also showed policymakers now support raising interest rates to the point at which economic activity is restrained.

“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 minutes of the of the Federal Open Market Committee, which were released on Wednesday, showed the alarm spreading through the top ranks of the US central bank over inflation, which is running at an annual pace of 8.6 per cent. The account also showed the lengths officials are willing to go to in order to ensure the price growth does not spiral even further out of control.

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

The minutes showed that participants increasingly recognise that their plans to tighten monetary policy will slow the pace of economic growth “for a time”. Most noted that the risks to the outlook were “skewed to the downside” given the possibility that further tightening could weigh even more on economic activity.

The minutes echoed recent comments from Fed chair Jay Powell, who has emphasised that the central bank has little room for manoeuvre 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 lockdowns in China to stop the spread of Covid-19.

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

“The process is highly likely to involve some pain, but the worst pain would be from failing to address this high inflation and allowing it to become persistent,” he said.

The account of the June meeting shed further light on why the Fed abruptly decided last month to dramatically step up the pace at which it is tightening monetary policy, opting to jettison its previously signalled plans for a second consecutive 0.50 percentage point rate rise.

Instead, a 0.75 percentage point increase lifted the federal funds rate to a new target range of between 1.50 per cent and 1.75 per cent.

The decision followed the publication of two economic reports, one showing a large jump in consumer prices in May and the other a rise in inflation expectations.

Participants expressed concern that the former report suggested inflationary pressures were not yet abating and “[solidified] the view that inflation would be more persistent than they had previously anticipated”, according to the minutes.

The June meeting also featured revised forecasts, which indicated officials envisage rates rising to what Powell said was a “modestly restrictive level” by the end of year of just under 3.5 per cent. Further rate increases that push the policy rate to 3.75 per cent are expected next year, before reductions in 2024.

Officials’ economic projections also went further in acknowledging that Fed action to quell inflation will cause economic pain, including higher unemployment and lower growth.

The minutes also detailed why the Fed scrubbed an important line in its policy statement last month, in which it had said it expected inflation to fall back to its 2 per cent target and the labour market to “remain strong” as it tightens monetary policy.

“As the further firming in the policy stance would likely result in some slowing in economic growth and tempering in labour market conditions, members also agreed to remove the previous statement language,” the minutes said.

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