MNI POST-FOMC: Scope for Steeper Path Down the Road

--Fiscal Policies Expected to Lift Growth, But Inflation Still Lags

--Powell Hopeful But Noncommittal on Boost to Productivity

By Jean Yung

     WASHINGTON (MNI) - Jay Powell, in his first press conference Wednesday as

Federal Reserve chair, emphasized policymakers' confidence that fiscal policy

and other factors will lift the economy over time, driving higher growth and

interest rates. 

     But the Federal Open Market Committee's reluctance to embrace a four-hike

baseline projection for 2018 suggests that a number of policymakers are waiting

for more signs of growth and inflation in the data before committing to a more

hawkish policy stance. 

     Over the medium term, policymakers added a hike in 2019 and projected the

fed funds rate would rise to 3.4% by end-2020, a sharp rise from the December

estimate and half a percentage point above the Committee's longer run estimate

of 2.9%.

     "Several factors are supporting the outlook," Powell said. "Fiscal policy

has become more stimulative, ongoing job gains are boosting incomes and

confidence, foreign growth is on a firm trajectory. And overall financial

conditions remain accommodative." 

     --INFLATION STILL LAGS

     However, inflation has yet to catch up. The core personal consumption

expenditure price index, viewed by the Fed as a key indicator of future

inflation, rose 1.5% year/year in January, short of the 2% target. Some of that

reflects one-off factors that will soon drop out of calculations, as the Fed has

repeatedly emphasized, and the FOMC forecasts it to rise to 1.9% by year-end and

to 2.1% beginning next year. 

     "On one hand the risk would be that we wait too long, and then we have to

raise rates quickly, and that foreshortens the expansion," Powell said. "On the

other side, if we raise rates too quickly, inflation then doesn't get

sustainably up to 2%, and that will hurt us going forward. We need that and we

need to make sure that inflation expectations are anchored at 2%." 

     "There is no sense in the data that we are on the cusp of an acceleration

of inflation," Powell added. 

     --'DIMINISHED' PHILLIPS CURVE

     Despite the dramatic fall in the unemployment rate since the financial

crisis, "you have only seen very gradual upward pressures on inflation and

wages," Powell said. 

     "That suggests that the relationship between changes in slack and inflation

is not so tight. It is diminished but it's still there." 

     The FOMC is "very alert" to an acceleration of inflation, both in wages and

in prices, as the jobless rate sinks below the sustainable rate of unemployment

for a sustained period, "but it's not something we observe at the present,"

Powell said. 

     Since both productivity and inflation have remained near historically low

levels, "these low wage increases do make sense," Powell said. But the very

modest increase in wages has "surprised" him and others. 

     In light of that puzzle, the Fed is aiming to "take the middle ground

here," he said. 

     --FUTURE 'HIGHLY UNCERTAIN'

     Asked whether stimulative fiscal policy would boost potential output via

productivity, and thereby driving growth and interest rates higher, Powell was

equivocal.  

     Three years out, the FOMC is forecasting a "modestly restrictive" policy

rate, but the trend is "highly uncertain," Powell emphasized. 

     "Is it possible that the neutral rate of interest would move up because of,

for example, greater fiscal expansion?" Powell said. "There are reasons that

that might be the case. In fact, it did tick up a tenth." 

     However, given the historical context of much higher rates, "the committee

sees the neutral rate of interest as still quite low and is not seeing it as

having moved up," he said. 

     That's not to say it won't. Officials are "open to the possibility that it

will," he said. The Republican tax bill contain incentives for additional

investment, Powell noted, through allowing certain expensing of such expenses

and that "should encourage productivity." 

     Lower tax rates should also encourage more people to enter the labor force,

he added. 

     Ramping up productivity is not something within the Fed's control, but "we

are certainly hopeful that there will be supply side effects like that from the

tax bill," he said. 

     Meanwhile, talk over trade tensions stoked by new tariffs out of the Trump

administration and the potential to affect economic activity and inflation for

now represents "a risk to the outlook," Powell said. 

     "There is no thought, I think, that changes in trade policy should have any

effect on the current outlook," though business contacts report it as a concern

going forward, he said. 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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