The U.S. Federal Reserve is facing a slowing labor market and persistently high prices, Chairman Jerome Powell said Tuesday in written testimony that suggests a rate cut is increasingly close.
The Fed has made “considerable progress” toward its goal of defeating the worst inflation surge in four decades, Powell said in testimony before the Senate Banking Committee later Tuesday.
“Inflation has eased considerably” over the past two years, he added, although it still remains above the central bank’s 2% target.
Jerome Powell stressed that “high inflation is not the only risk we face.” Cutting rates “too late or too little could unduly weaken economic activity and employment,” he said.
The Fed chairman was speaking to the Senate committee on the first of two days of semiannual testimony before Congress. On Wednesday, he will testify before the House Financial Services Committee.
From March 2022 to July 2023, the Fed raised its benchmark rate eleven times to its highest level in two decades at 5.3% to combat inflation, which peaked at 9.1% two years ago.
The hikes pushed up rates on mortgages, car loans and credit cards, among other forms of borrowing. The goal was to slow borrowing and spending and cool the economy.
On Tuesday, Mr. Powell noted that inflation reports covering the first three months of this year had not boosted Fed officials’ confidence that they have inflation under control.
“The most recent inflation data, however, have shown some further modest progress,” Powell told the Senate committee, “and more reliable data would strengthen our confidence that inflation is moving sustainably toward 2 percent.”
Gregory Daco, chief economist at EY, said he thought Powell’s “focus on bilateral risks to the outlook was welcome, if a little late.” Daco added that he thought the Fed should cut its benchmark rate at its July meeting. Otherwise, he suggested, companies could soon ramp up layoffs as the economy slows.
Market cooled, but strong
In the past, Mr. Powell and other Fed policymakers have repeatedly stressed that the strength of the economy and low unemployment meant they could be patient about cutting rates and wait to ensure that inflation was truly under control.
But on Tuesday, he said the labor market had “cooled but remained strong.” He added that economic growth had moderated after a strong expansion in the second half of last year. Last week, the government reported that hiring remained strong in June, although the unemployment rate rose for a third straight month to 4.1%.
The labor market “is not a source of broad-based inflationary pressures for the economy,” the Fed chairman said under questioning.
“It doesn’t seem likely that the next policy action will be a rate increase,” Powell said in response to a question from Senator Jack Reed, a Rhode Island Democrat. “As we move forward on inflation […]we are starting to relax our policy at the right time.”
Jerome Powell also told senators that the Fed and other financial regulators would review a proposal from last year that would have dramatically increased the amount of capital banks would be required to hold to offset potential losses.
The largest U.S. banks have vigorously opposed the proposal, arguing that stricter capital requirements would force them to cut back on lending to consumers and businesses.
U.S. financial institutions ran television ads opposing the proposal, known as the Basel III framework, which reflected the results of international negotiations over financial supervision that emerged from the 2007-08 financial crisis. Powell said the three major financial regulators — the Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency — were close to agreeing on a new proposal that would be submitted for public comment.
In his testimony, Jerome Powell also emphasized the Fed’s status as an independent institution, which he said “is necessary to take a longer-term perspective” on interest rate and inflation policy.
Raising borrowing costs to try to slow price increases is often politically unpopular, and economists have long argued that it is necessary to shield central banks from political pressure to allow them to take such measures.
“It feels like the Federal Reserve is setting a marker before the next presidential election,” said Joe Brusuelas, an economist at tax consulting firm RSM.
During his presidency, Donald Trump, in a highly unusual attack by a sitting president, repeatedly denounced Jerome Powell, whom he had nominated to be Fed chairman, for raising interest rates. Trump has already indicated that he would not nominate Mr. Powell if he were elected chairman again.
Last week, Mr. Powell told a policy conference in Portugal that there had been “quite a bit of progress on inflation,” something Fed officials have said they need to see consistently before they feel confident enough to cut rates. In May, year-over-year inflation fell to just 2.6%, according to the Fed, slightly above its 2% target and down sharply from its peak of 7.1% two years ago.
On Thursday, the government will release its latest results on the consumer price index (CPI). The CPI is expected to show an annual increase of only 3.1% in June, down from 3.3% in May.
Such signs of slowing inflation, along with evidence of a slowing economy and labor market, have intensified calls for the Fed to cut its benchmark rate. Several Democratic senators, including Elizabeth Warren of Massachusetts, a key member of the Senate Banking Committee, have written letters to Mr. Powell, urging him to start cutting the rate.
The probability of a Fed rate cut in September is about 76%, according to CME FedWatch, up from just 50% a month ago.
Mr. Powell’s comments last week and the minutes of the Fed’s June meeting released last week reinforced that likelihood. The Fed chairman noted that inflation had resumed its slowdown after data from the first three months of this year suggested inflation could accelerate.