Top Federal Reserve officials think entrenched inflation is a "significant risk" to the US economy and fear tighter monetary policy will be needed if price growth exceeds their expectations, according to an account of their most recent meeting.
The minutes of the US central bank's June meeting, when the Fed delivered the first 0.75 percentage point rate rise since 1994, also showed that policymakers now support raising interest rates to the point at which economic activity is restrained, with the possibility that they could become "even more restrictive" if warranted by the data.
"Many participants judged that a significant risk now facing the committee was that elevated inflation could become entrenched if the public began to question the resolve of the committee to adjust the stance of policy as warranted," the minutes said.
The notes from the Federal Open Market Committee, which were released on Wednesday, revealed the alarm spreading through the top ranks of the US central bank over inflation, which is running at an annual pace of 8.6 per cent. The account also showed the lengths officials were willing to go to ensure prices do not spiral further out of control.
The Fed will decide whether to raise rates by 0.50 percentage points or 0.75 percentage points at its meeting this month, although several officials have indicated their support for the larger increase.
"If inflation becomes entrenched in consumer and business psyches, it will be much more difficult to lower it over the medium term," said Kathy Bostjancic, chief US economist at Oxford Economics. "That is the breaking point for [the Fed], and they really want to do their best to ensure that it doesn't happen."
She added: "The longer inflation remains high, the more it will become embedded in expectations."
The minutes showed that participants were increasingly aware that their plans to tighten monetary policy would slow the pace of economic growth. Most noted that the risks to the outlook were "skewed to the downside" given the possibility that further tightening could weigh on activity.
The minutes echoed recent comments from Fed chair Jerome Powell, who has emphasised that the central bank has little room for manoeuvre as it tries to tame inflation without causing widespread job losses.
A US recession is now "certainly a possibility", and would in large part depend on factors outside of the Fed's control, he said last month, pointing to the war in Ukraine and prolonged Covid-19 lockdowns in China.
Powell reiterated that message last week on a panel with other central bankers, when he warned that a failure to restore price stability would lead to an even worse outcome for the US economy.
"The process is highly likely to involve some pain, but the worst pain would be from failing to address this high inflation and allowing it to become persistent," he said.
The account of the June meeting shed further light on why the Fed abruptly decided to dramatically step up the pace at which it is tightening monetary policy, opting to jettison its previously signalled plans for a second consecutive 0.50 percentage point rate rise.
Instead, a 0.75 percentage point increase lifted the federal funds rate to a new target range of between 1.50 per cent and 1.75 per cent.
The decision followed the publication of two economic reports, one showing a large jump in consumer prices in May and the other a rise in inflation expectations.
Participants expressed concern that the former report suggested inflationary pressures were not yet abating and "[solidified] the view that inflation would be more persistent than they had previously anticipated", according to the minutes.
The June meeting also featured revised forecasts, which indicated officials envisaged rates rising to just under 3.5 per cent by year-end. Further rate increases that push the policy rate to 3.75 per cent are expected next year before reductions in 2024. Officials also pencilled in higher unemployment and lower growth over that period.
The minutes detailed why the Fed scrubbed an important line in its policy statement last month, in which it had said it expected inflation to fall back to its 2 per cent target and the labour market to "remain strong" as it tightens monetary policy.
"As the further firming in the policy stance would likely result in some slowing in economic growth and tempering in labour market conditions, members also agreed to remove the previous statement language," the minutes said.
Written by: Colby Smith
© Financial Times