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Fed chair signals higher and faster rate hikes are on the horizon

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The central bank still has a “long way to go” in bringing inflation back to target.

Federal Reserve chair Jerome Powell has signalled that higher and faster interest rate hikes are on the horizon given the strength of recent economic data in the United States.

In his semiannual monetary policy testimony before the Senate Banking Committee on Tuesday local time, Mr Powell said that the central bank is prepared to increase the pace of rate hikes “if the totality of the data were to indicate that faster tightening is warranted”.

“The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,” he said.

In his testimony, Mr Powell noted that January data on employment, consumer spending, manufacturing production, and inflation in the US partly reversed the softening trends seen only a month earlier, which he said is likely partly a reflection of unseasonably warm weather.  

“Still, the breadth of the reversal along with revisions to the previous quarter suggests that inflationary pressures are running higher than expected at the time of our previous Federal Open Market Committee (FOMC) meeting,” he stated.

While moderating somewhat since the middle of last year, the Fed chair acknowledged that inflation still remains “well above” the FOMC’s target of 2 per cent.

According to Mr Powell, the Fed is beginning to see the effects of its policy actions on demand in the most interest-sensitive sectors of the US economy.

“It will take time, however, for the full effects of monetary restraint to be realised, especially on inflation,” he added.

The Fed slowed the pace of interest rate increases at each of its last two meetings, Mr Powell explained, “in light of the cumulative tightening of monetary policy and the lags with which monetary policy affects economic activity and inflation”.

“We will continue to make our decisions meeting by meeting, taking into account the totality of incoming data and their implications for the outlook for economic activity and inflation,” he said.

The 50 basis point (bp) hike announced last December and the 25 bp hike announced in February followed four consecutive 75 bp hikes between June and November last year. The Fed’s next interest rate decision is scheduled for 22 March (23 March in Australia). 

Despite the recent moderation in inflation, Mr Powell warned that the process of getting inflation back down to 2 per cent has a “long way to go and is likely to be bumpy”.

“Our overarching focus is using our tools to bring inflation back down to our 2 per cent goal and to keep longer-term inflation expectations well anchored,” he said.

“Restoring price stability is essential to set the stage for achieving maximum employment and stable prices over the longer run. The historical record cautions strongly against prematurely loosening policy. We will stay the course until the job is done.”

Following Mr Powell’s testimony, the likelihood of a 50 bp rate hike at the Fed’s March meeting rose from around 30 per cent to almost 70 per cent, according to the CME FedWatch tool, which is based on Fed Fund futures contract prices.

“The Fed is clearly data dependent and Powell’s remarks about the ‘totality of the data’ means that upcoming data releases are going to be important,” commented NAB currency strategist Rodrigo Catril.

“They will either vindicate the price action seen overnight and seal the deal for a 50 bps hike on March 22 or they will likely trigger a reversal.”

The hawkish comments from the Fed chair came after the Reserve Bank of Australia (RBA) softened its hawkish tone in its latest interest rate decision on Tuesday.

When asked whether Australia would be forced to follow the Fed and potentially increase rates at a higher rate than expected, Treasurer Jim Chalmers told ABC Radio National that developments in other major economies are “not completely irrelevant to what happens here”.

“One of the things that people who watch interest rates in the US and in Australia do watch closely is the differential between interest rates there and here,” he said.

“But they also look more broadly at the differential in what's called the trade weighted index of the various countries and what their monetary policy position is. That does have an impact, for example, on our dollar and a couple of other key parts of our economy. So people do watch that closely, it's not quite an automatic relationship but they watch it closely.”

Jon Bragg

Jon Bragg

Jon Bragg is a journalist for Momentum Media's Investor Daily, nestegg and ifa. He enjoys writing about a wide variety of financial topics and issues and exploring the many implications they have on all aspects of life.