Powell Targets High-or-Higher Rate Path as Economy Picks Up

The key takeaway: Monetary policy will stay “restrictive” until inflation is moving more firmly toward 2%.

“They haven’t seen the economy slow as much as they’d like, or the labor market slow as much as they’d like,” said William English, a professor at the Yale School of Management and a former advisor to Fed officials on policy strategy.

With the economy showing resilience — even picking up in the second quarter — and unemployment still low, it’s a message that could last for several months.

Even if the Fed forgoes a rate increase in September, policymakers are unlikely to declare the end of tightening any time soon. They’re aiming to steer clear of validating investor expectations for rate cuts next year, which could stoke growth.

While Fed officials differ over whether further tightening is needed, they’re voicing similar sentiment on the need to at least keep rates elevated.

“Under-tightening would be a worse mistake than over tightening a little bit because we can course-correct that,” Cleveland Fed President Loretta Mester said in an interview on Bloomberg Television on Friday following Powell’s speech. “We’re going to stay the course in terms of our monetary policy, making sure that we are restrictive enough so that inflation comes back down.”

Risk Management

Complicating the strategy are several uncertainties, that Powell referred to as “navigating by the stars under cloudy skies.”

Among those he cited: Fed officials can’t know in real time or with precision the exact level of rates needed to get the desired slowing in the economy. It’s also unclear how much their previous rate hikes have affected economic activity and financial markets, and how much of that impact is yet to come.

This makes it tougher for Fed officials to balance the risk of doing too much — and potentially triggering a sharp rise in unemployment and a subsequent downturn — against the risk of too little, which could allow inflation to become entrenched, Powell said.

“In such circumstances, risk-management considerations are critical,” he said. “We will proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data.”

Despite the nuanced message of balancing risks, Powell emphasized that the Fed’s overriding goal is restoring inflation back to its 2% target.

While he welcomed slower price gains in recent months, he noted the economy may not be cooling as fast as expected, which could put further inflation progress at risk and could warrant further tightening.

“Although inflation has moved down from its peak — a welcome development — it remains too high,” Powell said. “We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”

Speaking later Friday at Jackson Hole, European Central Bank President Christine Lagarde struck a similar note, saying the ECB will set borrowing costs as high as needed and leave them there for as long as it takes to bring inflation back to its goal.

‘Uncertainty’ Era

Describing an “era of uncertainty,” Lagarde said it’s important that central banks provide an anchor for the economy and ensure price stability in line with their respective mandates.

“In the current environment, this means — for the ECB — setting interest rates at sufficiently restrictive levels for as long as necessary to achieve a timely return of inflation to our 2% medium-term target,” Lagarde said.

For Fed officials, their fresh forecasts due next month will play a key role in setting expectations. Officials’ outlook on rates could show the potential for another increase this year.

Powell “has been leaning in to risks becoming more balanced, and he did it without coming across as dovish,” said Ellen Meade, a research professor at Duke University and former Fed Board staff member. “He gave us all the Volcker words again.”

The last line in Powell’s speech used the phrase “keep at it,” a nod to the title of former Fed Chair Paul Volcker’s biography “Keeping At It: The Quest for Sound Money and Good Government.”