Federal Reserve Chairman Jerome Powell said Tuesday that annual inflation might not return to the Fed’s goal of 2% until late next year or 2026.
The missive came during a moderated conversation with Powell alongside European Central Bank President Christine Lagarde and Banco Central do Brasil Governor Roberto Campos Neto on the sidelines of the annual ECB Forum on Central Banking in Portugal.
“You know, we don’t see ourselves getting back to 2% inflation this year or next year — well, maybe late next year — but in the year after,” Powell said. “The main thing is, we're making real progress.”
Powell was specifically asked where he thinks inflation will be at a year from now, and he said he expects it to be in the mid-to-low 2% range. He was referring to the headline personal consumption expenditures price index, which is the Fed’s preferred gauge of inflation.
As of May, PCE inflation is clocking in at 2.6%, meaning that the Fed expects inflation to hover around this range for some time, given Powell’s comments. The consumer price index, which is a more widely cited gauge of inflation, is higher and was punching in at 3.3% in May.
The remarks come after years of inflation fighting by the Fed and other central banks across the world. During the pandemic, the Fed slashed interest rates to near-zero in order help insulate the economy from the fallout of COVID-19 lockdowns and high unemployment.
In March 2022, two years after the coronavirus pandemic took hold, the Fed voted to raise interest rates in response to an alarming rise in inflation, which really started in early-to-mid-2021. Annual PCE inflation topped out at over 7% in June 2022, and CPI inflation crested at nearly 9% around the same time.
The Fed ended up hiking rates to 5.25-5.50%, the level the federal funds rate is at now. That is the highest rates have been since the dot-com bubble at the turn of the century.
When the Fed hikes interest rates, the action is done to dampen demand and thus slow inflation. But sometimes, raising rates by so much can cause unemployment to rise and economic output to fall, which has the potential to lead to a recession. Many economists had anticipated that the U.S. would slip into at least a mild recession last year, but that never came to fruition, and the labor market has remained resilient.
Paradoxically, in raising rates, the Fed was hoping to see some softening of the labor market and wage growth, which brings inflation down. The goal is to thread the needle of bringing inflation down while also avoiding too much unemployment or a recession.
But unemployment remained staggeringly low during much of the hiking cycle, even falling to 3.4% last year, the lowest level since 1969.
At the ECB forum on Tuesday, Powell noted that the unemployment rate in recent months has been slowly creeping up. As of May, it has risen to 4%. Nonetheless, it is worth noting that 4% is a historically healthy level of unemployment.
“What you see now is an unemployment rate that’s moving back up toward a more sustainable level. You see wage increases moving back down toward a sustainable level,” the Fed chairman said.
“Indeed, it looks like it's doing just what you would want it to do, which is to cool off over time, not quickly, not suddenly, not steeply,” Powell said.
In another sign of gradual softening, the number of job openings has generally begun to fall.
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Monthly openings peaked at 12.2 million in 2022, coinciding with a labor shortage, and have since fallen to 8.1 million as of May, the most recent data showed on Tuesday. The month before, in April, job openings fell to their lowest level since February 2021.
The most recent Fed projections show that central bank officials expect unemployment to remain at about 4% for the rest of this year and then rise to 4.2% by the end of 2025.
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