Fed prepares to react to rising inflation rate

Policymakers are ready ‘to stop pouring gasoline on the fire’ and withdraw support

Federal Reserve officials, worried about rising costs and buoyed by a healing labor market, are pivoting from bolstering the economic recovery to more quickly withdrawing the support that has aided the economy since the pandemic began.

The policymakers, who meet this week for their final gathering of 2021, are widely expected to outline a faster end to their bondbuying campaign and will telegraph how aggressively they expect to raise rates from rock-bottom next year.

The potential for major policy signals at the Fed’s meeting, which is set to conclude at 2 p.m. Wednesday, will make it one of the most closely watched of the pandemic era.

Officials took their first step toward weaning the economy off the central bank’s support in November, when they said they would begin to slow a large-scale bond buying program that had been in place since early in the pandemic to keep money flowing around markets and support the economy. In the weeks since the

Fed’s last meeting, fresh data has showed that consumer prices are climbing at the fastest pace in nearly 40 years and the unemployment rate has fallen to 4.2 percent, far below its pandemic peak.

Given inflation and growth trends, Fed officials signaled clearly that they would discuss withdrawing support more quickly at this gathering, and economists think officials will signal a plan to taper off bond purchases so that the buying will stop altogether in March.

Policymakers will also provide their latest thinking on the path for interest rates in their updated quarterly economic projections, and could pencil in two or three increases next year. When they last released the projections in September, officials were split on whether they would raise rates at all in 2022. Lifting the federal funds rate is arguably the Fed’s most powerful tool for pushing back on inflation, because it would slow demand and economic growth by percolating through the rest of the economy, lifting borrowing costs on mortgages, business loans and auto debt.

In late November, Jerome Powell,

the Fed chair, set the stage for the central bank’s shift from an economy-stoking stance to one that is more focused on keeping inflation under control.

“At this point, the economy is very strong, and inflationary pressures are high, and it is therefore appropriate in my view to consider wrapping up the taper of our asset purchases, which we actually announced at our November meeting, perhaps a few months sooner,” Powell said during congressional testimony on Nov. 30.

The Fed chair is expected to further explain during a post-meeting news conference on Wednesday how he is thinking about the central bank’s policy stance as it confronts rapid inflation and an uncertain economic path at a time when the virus shows no signs of abating and a new variant, omicron, complicates the outlook.

The Fed spent much of 2021 tiptoeing away from full-blast economic support, hoping to remove stimulus gradually enough that the job market would heal fully and quickly. But gradualism has given way to wariness in recent weeks, partly thanks to a new series of data points showing that inflation is still high and might stay elevated for some time.

Central bankers knew that prices would climb quickly in early 2021 as the economy recovered from the depths of the pandemic, but the increases have been strikingly broad-based and long-lasting. The gains are broadening beyond pandemic-sensitive goods and into rent and some services, and both wages and inflation expectations are picking up. Policymakers have increasingly questioned the wisdom of adding juice to the economy with each passing month.

“They’re realizing that they need to stop pouring gasoline on the fire,” said Gennadiy Goldberg, a rates strategist at T.D. Securities.

The Fed has two key jobs: keeping prices stable and fostering maximum employment. Progress on the second goal has also been notable in recent months. The unemployment rate has dropped sharply, falling to 4.2 percent in November and improving faster than Fed officials or most economist expected.

Even so, about 4 million jobs are still missing compared to before the pandemic. Some of those people may have retired, but others are expected to return to the job search once health concerns and pandemic-related child care problems become less pronounced. Many Fed officials had been hoping to keep their policies very accommodative as those people came back.

But inflation is forcing policymakers to balance their job market ambitions with their goal of keeping price gains under control. While an unhealed job market is bad for American households, so too are high and unpredictable price increases that chip away at paychecks and make it hard for businesses to plan. Plus, if the Fed waits too long to react to inflation, the fear is that they might have to lift rates sharply to bring it to heel, setting off a new recession.

“We have to balance those two goals when they are in tension as they are right now,” Powell said in testimony on Dec. 1. “But I assure you we will use our tools to make sure that this high inflation that we are experiencing does not become entrenched.”

While many Fed officials say they still expect high inflation to fade, plenty of signs suggest it is at risk of remaining too high for too long. Businesses report that they are raising wages or setting aside money as they prepare to pay more. Companies — from dollar stores to pizza shops — are lifting prices and finding that consumers accept the change.

Even companies taking a cautious approach to lifting prices express uncertainty about how long it will take to clear the supply chain snarls that are pushing up prices for inputs like food commodities and imported goods.