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The Federal Reserve has never forecast U.S. inflation to rise by more than 2.2% in the following year since the 2007-2009 Great Recession. Until now.
The Fed on Wednesday lifted its forecast for U.S. inflation in 2022 to 2.6% from its prior estimate of 2.2%, a belated recognition that price pressures won’t dissipate as rapidly as senior officials once believed.
And even that estimate is too low, some economists contend.
See: Fed accelerates taper of bond-purchases, eyes three interest rate hikes in 2022
Inflation has risen 5% in the 12 months ended in October to mark the fastest increase in 31 years, using the Fed’s preferred PCE price gauge. And prices have surged to the highest level in almost 40 years using the better-known consumer price index.
Just a little over a year ago, inflation was almost nonexistent.
These rapid price increases are starting to squeeze consumers. Retail sales in November, for example, barely rose and actually declined if adjusted for inflation.
In another notable move, Fed officials also dropped the word “transitory” from the official statement of the Federal Open Market Committee, the Fed body that sets U.S. interest rates. For months Chairman Jerome Powell and others had insisted the burst of inflation was temporary and would fade soon.
They are not saying that anymore.
“The Fed apparently just woke up to the inflationary pressures consuming the U.S. economy,” said Seema Shah, chief strategist at Principal Global Investors.
To be sure, Powell and most top Fed officials still think inflation will subside rapidly starting next year and return to pre-pandemic levels by 2024. They forecast inflation to slow to 2.3% in 2023 and 2.1% in 2024.
Yet they are worried enough to hedge their bets.
The Fed announced on Wednesday it will ditch a bond-buying stimulus program for the U.S. economy much sooner than previously planned. The central bank plans to end the purchases by March instead of June.
The Fed had been buying $120 billion in bonds a month in an effort to keep long-term interest rates low. The strategy helped consumers to obtain low rates for auto loans and mortgages and made it cheaper for businesses to invest.
Just as important, the move frees up the Fed to raise short-term interest as soon as it thinks it is necessary to keep inflation from getting further out of hand.
“We’ve been adapting our policy,” Fed Chairman Jerome Powell said on Wednesday in defense of his approach.
The central bank had been planning just one increase in its benchmark short-term interest rate in 2022, but now it’s aiming to raise rates three times, based on a dot plot of Fed intentions. And three more rate hikes are expected to follow in 2023.
The Fed had kept its benchmark rate near zero since early in the pandemic.
Will all these newly assertive moves be enough to squelch inflation?
Fed officials aren’t even sure it will all be necessary. They blame most of the increase in inflation on temporary shortages of labor and business supplies tied to the pandemic.
These shortages are expected to ease in 2022, but by acting more aggressively now, the Fed will better able to do something if it’s wrong about inflation. Again.
“There is a real risk now … that inflation may be more persistent,” Powell said. “I think we are in a position to deal with that risk. We are prepared to use our tools.”
