Federal Reserve Alert! Vice Chair Lael Brainard: 'Strong wage growth along with high rental and housing costs mean that inflation from core services is expected to ease only slowly from currently elevated levels.'
Federal Reserve Alert! Vice Chair Lael Brainard: 'Strong wage growth along with high rental and housing costs mean that inflation from core services is expected to ease only slowly from currently elevated levels. Monetary policy will be restrictive for some time to ensure that inflation moves back'
Source: https://www.federalreserve.gov/newsevents/speech/brainard20221010a.htm
Other notes from Vice Chair Brainard:
High inflation places a burden on all Americans, but especially lower-income families, who spend three-fourths of their income on necessities—more than twice the share spent by higher-income families. The Federal Reserve has tightened policy strongly to bring inflation down, and U.S. tightening is being amplified by concurrent foreign tightening. We are starting to see the effects in some areas, but it will take some time for the cumulative tightening to transmit throughout the economy and to bring inflation down.
Market expectations for the level of the policy rate at the end of the year are now more than twice as high as they were just seven months ago. As a result of the significant increase in interest rates and associated tightening in broader financial conditions, I now expect that the second-half rebound will be limited, and that real GDP growth will be essentially flat this year.
The moderation in demand due to monetary policy tightening is only partly realized so far. The transmission of tighter policy is most evident in highly interest-sensitive sectors like housing, where mortgage rates have more than doubled year to date and house price appreciation has fallen sharply over recent months and is on track to soon be flat. In other sectors, lags in transmission mean that policy actions to date will have their full effect on activity in coming quarters, and the effect on price setting may take longer. The moderation in demand should be reinforced by the concurrent rapid global tightening of monetary policy.
That said, a variety of indicators suggest labor demand remains strong, while labor supply remains below pre-pandemic conditions. The unemployment rate is now at the very low level that prevailed pre-pandemic, and the volume of quits remains elevated. This supply–demand imbalance in the labor market is reflected in strong wage growth. The employment cost index increased by an annual rate of 6.3 percent over the second quarter—its highest level in decades. A more-timely data source, average hourly earnings, decelerated slightly to a 4.4 percent annual rate over the third quarter, down from 4.6 percent annual growth in the second quarter. Although it is well above levels consistent with 2 percent inflation, wage growth has been running below current inflation.
Strong wage growth along with high rental and housing costs mean that inflation from core services is expected to ease only slowly from currently elevated levels. In contrast, core goods have been expected to return to something closer to the pre-pandemic trend of modest disinflation as a result of demand rotation away from goods to services, coupled with the healing of supply chains and declining core import prices.
Monetary policy tightening is also proceeding rapidly abroad. Many central banks in large economies have raised rates by 125 basis points or more in the past six months, and yields on 10-year sovereign debt in Canada, the United Kingdom, and the largest euro area economies have seen increases on the order of 190 to 360 basis points this year.
The combined effect of concurrent global tightening is larger than the sum of its parts. The Federal Reserve takes into account the spillovers of higher interest rates, a stronger dollar, and weaker demand from foreign economies into the United States, as well as in the reverse direction. We are attentive to the risk of further adverse shocks—for instance, from Russia's war against Ukraine, the pandemic, or China's zero-COVID policies. And we are also very aware that the cross-border effects of unexpected movements in interest rates and exchange rates, as well as worsening external imbalances, in some cases could interact with financial vulnerabilities. In this environment, a sharp decrease in risk sentiment or other risk event that may be difficult to anticipate could be amplified, especially given fragile liquidity in core financial markets. In some countries, the realization of these risks could pose challenging tradeoffs for policy.
That said, the real yield curve is now in solidly positive territory at all but the very shortest maturities, and the entire real curve will soon move into positive territory with the additional tightening and deceleration in inflation that are expected over coming quarters. Monetary policy will be restrictive for some time to ensure that inflation moves back to target over time. It will take time for the cumulative effect of tighter monetary policy to work through the economy broadly and to bring inflation down. In light of elevated global economic and financial uncertainty, moving forward deliberately and in a data-dependent manner will enable us to learn how economic activity, employment, and inflation are adjusting to cumulative tightening in order to inform our assessments of the path of the policy rate.