Powell and the Fed need to get back on course

Financial markets are coming around to the idea that the Federal Reserve means what it says about controlling inflation. In testimony to Congress this week, Fed Chair Jerome Powell said inflationary pressures had proved stronger than expected since the central bank raised rates by 25 basis points to a range of 4.5% to 4.75% last month. His hawkish comments left investors expecting a 50point increase at the next policy meeting — and for the moment dispelled any doubts about the Fed’s determination to get inflation back to 2%.

That’s all to the good. The more the Fed is believed, the easier its job will be.

Lately market expectations had called the Fed’s commitment into question. Many analysts expected a lower path for interest rates than the one the Fed had indicated in its most recent policy projection. In other words, investors believed either that inflation would subside faster than the Fed calculated, or that officials were bluffing about their willingness to press harder on the brakes if need be. Recent data followed by Mr. Powell’s new message put paid to both.

The underlying problem is no longer pandemic disruptions but excess demand and a too-tight labor market. This week’s report on job openings and labor turnover showed only the slightest decline in vacancies and quits — and there are still nearly two vacancies for every unemployed worker. New weekly jobless figures hinted that a turning point might be coming, but it hasn’t arrived yet. A labor market as hot as this cannot plausibly

slow growth in wages enough to bring inflation back to 2%.

The Fed still hopes to engineer a soft landing. Despite everything, it could well succeed. A somewhat higher path for interest rates — with a projected terminal rate of 6% rather than 5% — might be enough to cool the labor market and push inflation down without an outright recession, so long as investors think the Fed will do what’s required.

Mr. Powell’s forceful message this week helps for the time being. As he emphasized, there’ll be more data before the next meeting, and the Fed needs to keep an open mind — but absent clear signs of subsiding pressure, another 50-point increase in the policy rate will be warranted, together with a promise of more to come if necessary.

Mr. Powell and his colleagues will then need to gird themselves for the next challenge to their credibility. As price increases moderate in response to tighter policy, they will be told that inflation of 3% will do, and that getting all the way down to 2% isn’t worth the risk. The Fed should be willing to discuss how quickly inflation comes back down to target, but it even think about raising the target. Messaging that hints at the latter would make the target an upwardly movable floor, shatter the central bank’s credibility and make monetary policy even harder than it is already.

Investors have been reluctant to take the central bank at its word. That has to stop. From now on, the Fed needs to be firm.