WASHINGTON — The Federal Reserve faces a weakening job market and continuing high prices, Chairman Jerome Powell said in congressional testimony on Tuesday, signaling that the central bank is moving closer to cutting interest rates, a shift in focus from its inflation-fighting efforts of the past two years.
Powell told the Senate Banking Committee that the Fed has made “substantial progress” toward its goal of preventing the worst inflation spike in four decades.
He added that inflation has “easeing significantly” over the past two years but remains above the central bank’s 2% target.
“Higher inflation is not the only risk we face,” Powell said. “Cutting interest rates too little, too late, could weaken economic activity and employment too much.”
The Fed chairman spoke to the Senate committee on the first of two days of semi-annual testimony to Congress. He is scheduled to testify before the House Financial Services Committee on Wednesday.
From March 2022 to July 2023, the Fed will raise its benchmark interest rate 11 times to 5.3%, the highest in the past 20 years, to combat inflation. Inflation peaked at 9.1% two years ago. The hikes have led to higher interest rates on mortgages, auto loans, credit cards and other debt, increasing borrowing costs for consumers. The aim was to slow borrowing and spending and cool the economy.
Powell noted Tuesday that inflation reports for the first three months of the year did not boost Fed officials’ confidence that inflation is coming under control.
“But the latest inflation readings suggest some further progress,” Powell told the Senate committee. “As we get better data, our confidence will increase that inflation is on a sustained path to 2 percent.”
Gregory Daco, chief economist at consulting firm EY, said Powell’s “greater emphasis on two-sided risks to the outlook is welcome, if a little overdue.” Daco added that he also thinks the Fed should cut interest rates at its July meeting. Otherwise, he suggested, companies may soon start cutting more jobs as the economy slows.
Chairman Powell and other Fed policymakers have repeatedly stressed that the strength of the economy and low unemployment mean they can be patient about cutting rates and wait for inflation to truly subside.
But Powell said Tuesday that the job market is “quite cooling,” adding that economic growth is slowing after a strong expansion in the second half of last year. Last week, the government reported that hiring held steady in June but the unemployment rate rose for a third straight month, to 4.1%.
In response to a question, the Fed chairman said the labor market was “not a source of inflationary pressure for the overall economy.”
Powell did not offer any clear indication of when the Fed will cut interest rates for the first time — a major focus for Wall Street investors — but his testimony is likely to strengthen expectations among investors and economists that the first rate cut will come when the central bank meets in September.
“It seems unlikely that our next policy action will be an interest rate hike,” Powell said in response to a question from Sen. Jack Reed, D-Rhode Island. “If we see further progress on the inflation issue, we will begin to ease policy at the appropriate time.”
Powell also told senators that the Fed and other financial regulators plan to revise a proposal from last year to significantly increase the amount of capital banks must hold to offset potential losses.Big U.S. banks strongly opposed the proposal, arguing that tougher capital requirements would force them to make less loans to consumers and businesses.
U.S. financial institutions ran television ads opposing the proposals, known as the “Basel III endgame,” which mirror the results of international talks on financial oversight born out of the 2007-2008 financial crisis. Powell said the three main financial regulators — the Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency — were close to agreeing on new proposals that would be open to public comment.
In his testimony, Chairman Powell emphasized the Fed’s independent status and said it “needs to take a long-term view” on interest-rate policy and inflation. Raising borrowing costs to curb price increases is often politically unpopular, and economists have long believed that central banks need protection from political pressure to take such measures.
“The impression is that the Fed is setting a landmark for the upcoming presidential election,” said Joe Brusuelas, an economist at tax advisory firm RSM.
In a highly unusual attack from a sitting president, President Donald Trump has repeatedly criticized his nominee for Fed chair Powell for raising interest rates during his presidency, and has already indicated he would not reappoint Powell if he is re-elected.
“Inflation has made a lot of progress,” Powell said at a monetary policy meeting in Portugal last week, something Fed officials have consistently said they need to see before they feel confident enough to cut rates. Inflation, the Fed’s preferred measure, fell to 2.6% year-on-year in May, just above the Fed’s 2% target and down sharply from a peak of 7.1% two years ago.
The government will release the latest reading of its well-known consumer price index on Thursday. The CPI is expected to rise just 3.1% year-on-year in June, down from 3.3% in May.
These signs of subsiding inflation, along with evidence that the economy and job market are slowing, have prompted calls for the Fed to cut interest rates. Several Democratic senators, including Sens. Sherrod Brown (R-Ohio), chairman of the Senate Banking Committee, and Elizabeth Warren (R-Mass.), have written to Chairman Powell urging him to start cutting interest rates.
