US Federal Reserve expects economic growth surge and inflation jump in 2021

The central banking system said the economy could see the fiercest growth in decades but didn't issue a rate increase after a two-day meeting

The US economy is heading for its strongest growth in about 40 years, the Federal Reserve said. Reuters

The US economy is heading for its strongest growth in about 40 years, the Federal Reserve said on Wednesday, and central bank policymakers are pledging to keep their foot on the gas despite an expected surge of inflation.

"Strong data are before us," a confident Fed chair Jerome Powell said after a two-day policy meeting, ticking off the list of forces Fed officials expect will produce 6.5 per cent GDP growth this year – from a big federal fiscal stimulus to optimism around the success of coronavirus vaccines.

"The [stimulus] cheques are going out ... Covid cases are coming down. Vaccination is moving quickly," Mr Powell said, marking a moment in which a body of top US economic officials expect growth in the United States to rival that of China this year, not to mention surging quickly beyond that of Europe and Japan.

Fed officials, in fact, expect economic growth to remain above trend for at least two years to come, at 3.3 per cent in 2022 and 2.2 per cent in 2023, compared to estimated long-term potential growth of only 1.8 per cent.

"We are not actually done yet. We are clearly on a good path. But we are not done, and I would hate to see us take our eye off the ball."

While inflation is expected to jump to 2.4 per cent this year, above the central bank's 2 per cent target, Mr Powell said that is viewed as a temporary surge that will not change the Fed's pledge to keep its benchmark overnight interest rate near zero as part of an effort to ensure the economic wounds from the pandemic are fully healed.

Opinions among the Fed's 18 current policymakers did shift somewhat, with four now expecting rates may need to rise next year and seven seeing a rate increase in 2023.

But in overlooking the expected jump in inflation this year without a policy response, the Fed held true to its new framework and a pledge not to overreact at the first hint of rising prices, a reaction that has in the past been felt to nip off periods of growth before workers felt the full benefits.

Fed officials now expect inflation to remain tame even as the unemployment rate drops, a calculated gamble under their new approach that emphasises employment gains and downplays inflation risks.

Mr Powell noted the "strong bulk" of the policy-setting Federal Open Market Committee anticipates no interest rate increase until at least 2024, and he added that it was even too soon to talk about scaling back the $120 billion of Treasury bonds and mortgage-backed securities the Fed is buying each month to further prop up the economy.

The committee's policy statement, which kept the benchmark overnight interest rate in a target range of 0 to 0.25 per cent, was unanimous.

"We are committed to giving the economy the support it needs to return as quickly as possible to a state of maximum employment," Mr Powell said in a briefing after the Fed released its new economic projections and latest policy statement.

"We are not actually done yet. We are clearly on a good path. But we are not done, and I would hate to see us take our eye off the ball ... There are in the range of 10 million people who need to get back to work."

Markets had relaxed by the end of Mr Powell's briefing, with the Fed chief and the central bank having avoided potential disruption had they signalled that stronger economic forecasts would lead to a faster-than-expected move to scale back support for the economy.

US stocks ended the day higher, with the S&P 500 index and Dow Jones Industrial Average closing at record highs. Yields on US Treasuries on the longer end of the curve remained elevated, while those on shorter-term debt fell.

"There was just a lot of anxiety, which definitely pumped up bond yields so far, but the Fed's very dovish kind of response for a quite strong economic outlook is a big sigh of relief," said Anthony Denier, chief executive of trading platform Webull.

Compared with the Fed's first pandemic-era forecasts, issued in June of last year, the projections issued on Wednesday were a remarkable turnabout after a year some worried would produce a new Great Depression, and during a pandemic that claimed more than half a million lives in the US.

The unemployment rate is now seen falling to 4.5 per cent by the end of this year, compared to the projection in June of 6.4 per cent. It is forecast to fall even lower next year, reaching levels that would once have been considered near or below what economists view as full employment.

The projected 6.5 per cent growth in gross domestic product would be the largest annual jump since 1984.

After the rise in prices this year, the Fed expects inflation to fall back to 2 per cent in 2022.

"Considering the disruption and economic upheaval of the last year, this is mind-blowing," wrote Seema Shah, chief strategist for Principal Global Investors.