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For Powell, the labor market is what takes inflation so long to reach its 2% target

At the ECB Forum on Central Banking held in Sintra, Portugal, central bank bosses, Jerome Powell of the U.S. Federal Reserve, Christine Lagarde of the European Central Bank, Andrew Bailey of the Bank of England, and Kazuo Ueda of the Bank of Japan; have all gathered to discuss central banking, monetary policy, and global macroeconomic conditions.

U.S. Inflation Rate, May 2020-May 2023

source: Statista

For the boss of the U.S. central bank, the reason why inflation is taking so long to reach the 2% target is that the labor market remains strong, although it has slowed down overall. In early 2022, inflation was nearing 10%. After ten consecutive interest rate hikes, inflation was brought down to 4%. While these results are impressive, Jerome Powell is still not satisfied because the current inflation rate is far above its 2%-target rate.

The resilience of the labor market is what slows down the progress of disinflation. The U.S. Bureau of Labor Statistics data shows that while unemployment slightly increased between April and May 2023, unemployment overall remains very low. Since the beginning of the year, non-farm payroll employment has increased considerably, and wage pressures increased as well.

The wage-push inflation incentivizes consumers to continue spending. Indeed, higher wages give workers more disposable income, which they can then use to buy goods and services. This increased demand can put upward pressure on prices, leading to further inflation. Moreover, higher wages can lead to businesses raising prices in order to maintain their profit margins. This can also lead to consumer demand, as people may be willing to pay higher prices for goods and services if they have more disposable income. And this is what Jerome Powell fears.

What Powell is mainly concerned about is reducing consumer demand in order to continue taming inflation and bringing it back to its 2%-target rate. And the only way to continue reducing consumer demand to meet inflation targets is by continuing increasing interest rates. Chairman Powell reiterated at the forum that the Federal Reserve will continue hiking interest rates twice more by the end of the year. It is unlikely that inflation will hit its 2% target by the end of the year. Powell remains realistic about this. He does not expect inflation to drop to its core target.

Powell also indicated that it is unlikely that the market will see an interest-rate cut. The economy, while heading in the right direction, remains susceptible to significant inflationary pressures, which could bring inflation back to elevated levels. And that would annul all the rate hikes that the Fed has been implementing since March 2022.

Lastly, Powell did not exclude the possibility of a recession in the next two years to come. While he believes that a soft landing will be the best-case scenario to reduce consumer demand and bring inflation down, he remains open to the idea of maybe forcing a hard landing scenario if inflation takes too long to reach its 2% target.

This means that the Federal Reserve may resort to raising interest rates aggressively, which will tighten even further the credit market, which in turn, will boost unemployment in the labor market. Consumer demand will surely be reduced, but it will be at a hefty cost. The cost of ordinary Americans losing their jobs and maybe their homes because of the inability to make mortgage payments due to the lack of recurring income.


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