On the longest day of the year, Federal Reserve Chairman Jerome Powell addressed concerns about inflation and weakness in the U.S. economy before the U.S. House Committee on Financial Services. Powell warned that the fight against inflation is far from over and will be a difficult battle, with negative impacts on the economy and labor markets expected before reaching price stability of 2 percent inflation. He emphasized that inflation pressures remain high and getting inflation back down to 2 percent will be a long process. Powell also noted that longer-term inflation expectations seem to remain stable, which can be dangerous as it can lead to self-fulfilling prophecies of higher inflation. He confirmed that the Federal Reserve is likely to raise interest rates again this year, but the details regarding the magnitude and timing were not provided.
Powell’s comments come in light of the latest U.S. Consumer Price Index (CPI) data, which showed a decrease in headline CPI to 4.0 percent in May (from 4.9 percent in April), while core CPI (excluding food and energy) increased to 5.3 percent. The rise in headline CPI was driven by increasing costs of shelter, food, and transportation, offset by declining energy prices. In addition, the Personal Consumption Index (PCE), the Fed’s preferred inflation measure, increased in the latest period.
Persistently high inflation has significant consequences as it compounds over time, making people poorer faster. The markets reacted negatively to Powell’s comments about potential interest rate increases, and there have been recent bank failures indicating that interest rates were raised too quickly. Further rate increases could put additional strain on the banking system, leading to potential more bank failures. It is acknowledged that reducing inflation will require below-trend growth and a softening of labor market conditions.
The United States is not the only country struggling with inflation. The UK and Europe also face high inflation rates. The UK Consumer Prices Index (CPIH) increased to 7.9 percent in May, and European inflation remained at 6.1 percent in May, with expectations of 5.4 percent for the full year 2023. The European Central Bank raised interest rates by 25 basis points in response.
Market expectations in the United States suggest a continuation of slowing inflation, although there is a risk of reversal in the coming months, particularly if energy markets strengthen. A surprise output reduction from OPEC+ countries could tighten the global oil market and increase prices. Chairman Powell did not mention this risk in his testimony, but it is significant.
To defend against future energy-driven inflation, the United States should focus on establishing energy independence and strengthening domestic oil and gas industries. However, the Biden administration’s stance on domestic energy policy may hinder this defense, leaving the country vulnerable to adversarial nations and persistent high inflation.