Federal Reserve chief Jerome Powell warned of higher-than-anticipated interest rates in his testimony in front of Congress on Tuesday.
Last December, Fed officials estimated that the terminal rate would be around 5.1 percent. However, data from global financial firm CME Group revealed that 69 percent of investors now predict the terminal rate will range from 5.5 to 5.75 percent.
"The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated," Powell said.
"If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes."
Analysts explained that the Fed might fasten the pace of its rate hike after opting to increase the interest rate by only 25 basis points last month. Some investors projected that the Fed would increase the rate by 50 basis points in the Federal Open Market Committee meeting later this month.
New data indicated that inflation was still well above the Fed's two percent target. Consumption expenditure prices — the Fed's preferred inflation indicator for its broad coverage of the economy — showed an annual increase of 5.4 percent in January.
Meanwhile, the job report for January showed an addition of 517,000 payrolls — 200,000 higher than initial estimates. The robust job market increased the risks of prices going up further due to wage inflation. The government will publish the job report for February, which experts predict will still indicate a tight labor market.
In his testimony, Powell argued that hot inflation data from January might result from "unseasonably warm weather." Better weather means less disruption in construction, mining and other weather-sensitive sectors, leading to fewer layoffs. Consumers also likely go out and spend their money in warmer weather.
“We have covered a lot of ground, and the full effects of our tightening so far are yet to be felt. Even so, we have more work to do.”
Jerome Powell, Chairman of the Federal Reserve
Regardless, the Fed chairman acknowledged that his agency still has "more work to do" in its fight against inflation even if it has already "covered a lot of ground." He added that the road to bringing down inflation could be "bumpy."
Powell also responded to demand by Democrats in the Senate Banking, Housing and Urban Affairs Committee to reconsider its monetary tightening policy. Democratic Sen. Elizabeth Warren of Massachusetts said the Fed's inflation target would put two million people out of employment.
"We're taking the only measures we have to bring inflation down," the Fed chief answered. "Will working people be better off if we just walk away from our jobs if inflation remains at 5, 6 percent?"
Powell said past data had shown that loosening monetary policy "prematurely" would result in severe market volatility. The chairman asserted that the Fed would maintain its restrictive monetary policy until the job was "done."
The chief maintained that the central bank would decide on rates "meeting by meeting," depending on data and the impact of rate hikes on inflation and economic activity.
Hard landing for U.S. economy
James Knightley, chief international economist at financial service firm ING, said the U.S. economy could head to a hard landing if the Fed decided to take on a more hawkish approach to combat inflation. A hard landing is a steep economic downturn following rapid growth, it can be a slowdown in growth or even an economic contraction.
Knightley warned that monetary policy works with "long and varied lags," meaning that the economy has yet to fully experience the effects of the Fed's monetary tightening. The policy would not only increase borrowing costs but also reduce credit availability as banks pull back from lending.