Yellen Sees Inflation Key Uncertainty Amid Moderate Growth

But she said it was 'premature' to say that inflation won't reach the Fed's 2% target over the next couple of years

Federal Reserve Board Chair Janet Yellen. (Photo: AP) Federal Reserve Board Chair Janet Yellen. (Photo: AP)

Federal Reserve Board Chair Janet Yellen said the U.S. economy should continue to expand over the next few years, allowing the central bank to keep raising interest rates, while also stressing the Fed is monitoring too-low inflation.

“Considerable uncertainty always attends the economic outlook,” Yellen said Wednesday in remarks prepared for delivery to the U.S House Financial Services Committee. “There is, for example, uncertainty about when — and how much — inflation will respond to tightening resource utilization.”

U.S. stocks opened higher while Treasury yields fell with the dollar after her testimony was released.

In a question-and-answer session with lawmakers, Yellen said the Fed is considering risks around the inflation outlook, while she also cited “temporary” influences, such as quality-adjusted costs of mobile-phone plans and prescription drugs, that are holding down price measures.

“To my mind, a prudent course is to make some adjustments as long as our forecast is that we’re heading back to 2%” inflation, Yellen said. “It is premature to reach the judgment that we are not on the path to 2% inflation over the next couple of years.”

She repeats the performance Thursday before the Senate Banking Committee, wrapping up her final testimony to Congress as Fed chair, unless she is re-nominated by President Donald Trump. Yellen’s current term expires on Feb. 3.

“We thought that it was pretty balanced and a pretty steady continuation of the themes” that Yellen had laid out after the Fed’s meeting last month, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. “It was pretty straight down the middle.”

Yellen emphasized in her remarks that the central bank is on alert about prices remaining below the central bank’s 2% target. Other members of the Federal Open Market Committee have mentioned similar concerns in recent days.

“The committee will be monitoring inflation developments closely in the months ahead,” she said.

Nevertheless, the Fed chair said, the baseline outlook is for levels of interest rates to continue to support job gains and income growth and therefore consumer spending.

A faster pace of global growth should support U.S. exports, she said, and a recovery in drilling activity should support business investment.

“These developments should increase resource utilization somewhat further, thereby fostering a stronger pace of wage and price increases,” she said.

Yellen said the central bank’s policy rate “would not have to rise all that much further” to get to a rate that keeps supply and demand in balance in the economy. Eventually, “factors,” which she did not specify, holding down the so-called neutral rate will diminish over time, she said, which supports the Fed’s case for continued rate hikes over the next couple of years.

Balance Sheet

She also mentioned that the Fed anticipates it will start reducing its balance sheet “this year.” The size of the balance sheet once this process has been completed is uncertain, she said, partly because the banking system’s demand for reserves is not yet known.

Yellen said low readings on inflation are partly the result of “a few unusual reductions” in certain price categories which will hold 12-month inflation down until they drop out of the calculation. However, she also said there is uncertainty about inflation’s response to tightening resource use.

She noted that the FOMC said in June it will “carefully monitor actual and expected progress” toward its inflation goal.

Inflation has been below the central bank’s 2% target for most of the past five years.

With U.S. economy growing at a steady pace, Yellen’s Fed is gradually pulling back from crisis-era stimulus. It raised interest rates in June for a second time this year and forecast another hike in 2017.

The U.S. expansion is in its ninth year and continues to create jobs without much inflation. Unemployment was 4.4% in June and employers have added 187,000 jobs a month on average over the past 12 months. But stronger demand for labor hasn’t fed into higher wages.

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