US rates to rise gently amid strong growth

Federal Reserve Chairman Jerome Powell . Joshua Roberts/Reuters

Federal Reserve Chairman Jerome Powell said the central bank can continue gradually raising interest rates as the outlook for growth remains strong, and the recent bout of financial volatility should not weigh on the US economy.

"Some of the headwinds the US economy faced in previous years have turned into tailwinds," Mr Powell said in written testimony to the House Financial Services Committee on Tuesday in Washington. "Fiscal policy has become more stimulative and foreign demand for US exports is on a firmer trajectory.''

Mr Powell takes over the rate-setting committee at a time when the world's largest economy may be shifting gear to faster growth, somewhat higher inflation and declining unemployment. Adding to the momentum are tax cuts and spending increases agreed to by Republican lawmakers and signed by President Donald Trump.

“In gauging the appropriate path for monetary policy over the next few years, the FOMC will continue to strike a balance between avoiding an overheated economy and bringing PCE price inflation to 2 per cent on a sustained basis,’’ he said, in his first public appearance before Congress as Fed chief.

The recent correction in the stock market and rising rates on US government debt shouldn’t hamper growth, he said.

"We do not see these developments as weighing heavily on the outlook for economic activity, the labour market and inflation," Mr Powell said. "Indeed, the economic outlook remains strong.''

Hel repeated the FOMC’s January message, saying “further gradual increases’’ in the Fed’s policy rate “will best promote’’ the attainment of the central bank’s objectives of maximum employment and stable prices.

"He is optimistic," said Ward McCarthy, chief financial economist at Jefferies. "He is sending a clear message: the economy is back to normal and we have to get policy back to normal."

The central bank has been struggling with too-low inflation. The personal consumption expenditures price index has been below the central bank’s 2 per cent target for most of the past five years.

“We anticipate that inflation on a 12-month basis will move up this year and stabilise around the FOMC’s 2 per cent objective over the medium term,’’ Mr Powell said.

He said the lag in wages during the expansion was due to low gains in output per hour, or productivity, though a new wave of investment spending "should support higher productivity growth in time".

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"Wages should increase at a faster pace as well," Mr Powell said. He said the FOMC continued to view the shortfall in inflation last year "as likely reflecting transitory influences that we do not expect will repeat".

The economy will expand at 2.7 per cent rate this year, according to the median estimate in a Bloomberg survey, while headline inflation will rise to 1.9 per cent.

“The comprehensive tax reforms passed at year-end 2017 provide significant fiscal stimulus to the economy, and the recent budget agreement further stiffens fiscal tailwinds over the medium term," said Carl Riccadonna, chief US economist at Bloomberg Economics

US central bankers predicted they would increase the benchmark lending rate three times this year in their December forecasts, and investors widely expect the central bank will act at its policy meeting next month. Faster growth may test that gradual pace after years of modest economic performance.

A brightening economic outlook, and the possibility that it could prod the Fed to raise rates at a faster pace, have prompted a reaction in financial markets also adjusting to the prospects of stepped-up US government debt issuance to fund a widening budget deficit.

Yields on US government 10-year notes fell slightly Tuesday to 2.85 per cent after orders for business equipment at US factories unexpectedly declined. The S&P 500 Index opened little changed at 2781.11 at 9.41am New York time.