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The Scotiabank branch at Bingham Ave. and Kingston Road.Fred Lum/The Globe and Mail

Jerome Powell signalled the beginning of the end of the U.S. Federal Reserve’s extraordinary COVID-19 pandemic response on Friday, indicating the world’s most powerful central bank could begin paring back stimulus before the end of the year.

The speed of the U.S. economic recovery has exceeded expectations, and the outlook for the job market has “brightened considerably in recent months,” the Fed chairman said in a closely watched speech to a virtual meeting of the annual Jackson Hole summit for central bankers and other policy makers and economists.

Mr. Powell also argued that the recent surge in inflation is likely a temporary phenomenon, and said central bankers should exercise caution when tightening monetary policy before labour markets have healed.

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Even with a spike in Delta-variant cases of COVID-19, the improving U.S. economy could push the Fed to start reducing its pace of asset purchases before the end of the year, Mr. Powell said. The central bank has been buying US$120-billion worth of government-backed bonds every month since the start of the pandemic in an effort to hold down interest rates to stimulate borrowing and spending.

“We have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals. … My view is that the ‘substantial further progress’ test has been met for inflation. There has also been clear progress toward maximum employment,” Mr. Powell said.

A reduction in bond buying would move the Fed in the direction of the Bank of Canada, which has cut its weekly purchases of federal government bonds twice since April. The bank continues to target around $2-billion worth of bond purchases a week, down from $5-billion at the start of the pandemic.

National Bank interest rates strategist Taylor Schleich said Mr. Powell’s speech is unlikely to have much impact on Bank of Canada policy, although it did reinforce messages bank Governor Tiff Macklem has been delivering for months.

“We’ve seen over the last, almost a year now, the Bank of Canada is willing to taper and move on its own asset purchases, independent of what the Fed is doing,” Mr. Schleich said. “But I think maybe the Bank of Canada gets a little bit more confident in their stance that the inflationary pressures are transitory, because Powell really doubled down on that.”

Much of Mr. Powell’s speech focused on the recent spike in inflation. In June and July, the U.S. consumer price index rose 5.4 per cent compared with the same months the previous year, which is the fastest pace of consumer price growth since 2008. In Canada, the CPI rose 3.7 per cent in July compared with the previous year, the biggest jump in a decade.

Mr. Powell argued the run-up in prices was largely “the product of a relatively narrow group of goods and services that have been directly affected by the pandemic and the reopening of the economy.”

Central bankers need to be careful at moments like this, he warned: “If a central bank tightens policy in response to factors that turn out to be temporary, the main policy effects are likely to arrive after the need has passed. The ill-timed policy move unnecessarily slows hiring and other economic activity and pushes inflation lower than desired.”

Avery Shenfeld, chief economist of CIBC World Markets, said the Bank of Canada largely shares this view that current above-target inflation is transitory. Financial markets are also pointing toward relatively subdued inflation over the medium-term, he said.

“The market certainly is not particularly worried about inflation or we would have bond yields a lot higher than they are right now,” Mr. Shenfeld said.

“As for economists, there are some nervous Nellies … myself included, who accept that this inflation pop is transitory, but think that we might be building up some inflation pressures for a year from now, that will be different and less transitory. But there’s lots of time to raise interest rates in 2022 or 2023 to slow the economy and prevent that from being a problem.”

Mr. Powell gave no hints as to when the Fed may start increasing interest rates, which it has held at rock bottom during the pandemic. By contrast, the Bank of Canada has indicated it may start to raise rates as early as the second half of 2022.

“The Fed doesn’t have the luxury of being like the Bank of Canada,” said James Orlando, a senior economist with Toronto-Dominion Bank. “When they make a move it reverberates through global markets significantly. So the Fed has been a little bit more patient, a little bit more cautious with its tone and with how it conducts monetary policy.”

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