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Fed to begin removing support for the economy as inflation worries mount

Global supply chain in crisis
Global supply chain in crisis 06:26

The Federal Reserve will begin dialing back the extraordinary economic aid it has provided since the pandemic erupted in early 2020, a response to high inflation that now looks likely to persist longer than it did just a few months ago. As expected, the central bank left rates unchanged.

In a statement Wednesday after its latest policy meeting, the Fed said it will start reducing its $120 billion in monthly bond purchases in the coming weeks by about $15 billion a month, though it reserved the right to change the pace of tapering. Those purchases have been intended to hold down long-term interest rates to encourage borrowing and spending. With the economy recovering, that's no longer needed.

Much watched among investors and economists were the Fed's comments about inflation, which Fed Chair Jerome Powell has consistently described as "transitory." Yet the consumer price index — which measures the cost of items such as housing and cars — has been elevated since April, with inflation hovering between 4% to 5%. 

Many economists expect the supply-chain bottlenecks contributing to higher inflation to persist well into 2022. But the Fed on Wednesday maintained its stance that inflation is "transitory," although it slightly softened that view.

"The statement does add a little more to the inflation assessment, but the language is still surprisingly dovish," Paul Ashworth, chief U.S. economist at Capital Economics, told investors in a research note. "Previously, the statement noted that 'inflation is elevated, largely reflecting transitory factors,' whereas the new statement says that 'inflation is elevated, largely reflecting factors that are expected to be transitory'."

In a press conference after the Fed released its policy statement, Powell attributed the inflationary pressures that are boosting prices largely to factors related to the COVID-19 pandemic, as well as to supply and demand imbalances.

IMF's chief economist says inflation pressure to persist into next year 06:21

The Fed will slow its $80 billion in monthly Treasury purchases by $10 billion a month and its $40 billion in mortgage-backed securities purchases by $5 billion in November and December — and it said similar reductions "will likely be appropriate" in the following months. That suggests the central bank might decide to accelerate its pullback in bond buying if inflation worsens.

Inflation is forecast to stand close to 5% for 2021, according to the Federal Reserve Bank of Minneapolis. That's souring many Americans on the nation's financial outlook, with more than 6 in 10 calling the economy poor, according to polling from the Associated Press-NORC Center for Public Affairs Research. 

The Fed underscored Wednesday that the nation's economic rebound depends "on the course of the virus."

"Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation," it said in its statement.

Rate hikes next year?

If the pace of Fed tapering is maintained, the bond purchases would end altogether in June. At that point, the Fed could decide to raise its benchmark short-term interest rate, which affects many consumer and business loans.

The changes reflect a central bank that is rapidly shifting from an effort to boost the economy and encourage more hiring to one that is increasingly focused on tamping down rising inflation. Prices jumped in September from a year earlier at the fastest pace in three decades. The Fed now faces the delicate task of winding down its low-rate policies, which it hopes will slow inflation, without doing that so rapidly as to weaken the job market or even cause another recession.

The economy has steadily recovered from the pandemic recession, although growth and hiring stumbled in the July-to-September quarter, partly because a surge in delta variant cases discouraged many people from traveling, shopping and eating out.

Many economists say they're hopeful that with vaccinations increasing and the delta wave fading, job growth will pick up in October from September's weak pace. The October jobs report will be released Friday.

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