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Federal Reserve Chair Jerome Powell testifies during a U.S. House Oversight and Reform Select Subcommittee hearing, in Washington, on June 22, 2021.POOL/Reuters

Federal Reserve Chair Jerome Powell said on Wednesday he would support a 25-basis-point interest rate hike at the U.S. central bank’s March 15-16 policy meeting and would be “prepared to move more aggressively” if inflation does not abate as fast as expected.

Effectively ending debate that the Fed might begin a liftoff in borrowing costs with a half-percentage-point increase in its benchmark overnight interest rate, Powell told lawmakers he was “inclined to propose and support a 25-basis-point rate hike” at this month’s meeting, the first of what he said he anticipated would be “a series of rate increases this year.”

Powell added that “it may be well be” that over time the central bank’s policy rate, currently set near zero, would have to rise even to restrictive levels of 2.5 per cent or more in order to get inflation back under control.

But Powell’s appearance before the U.S. House of Representatives Financial Services Committee was framed by the war in Ukraine, and while the Fed chief said it “remains to be seen” if the conflict will shift the central bank’s policy path it already had put a premium on caution and an openness to possibly abrupt changes in economic conditions.

“The near-term effects on the U.S. economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain,” Powell said. “Making appropriate monetary policy in this environment requires a recognition that the economy evolves in unexpected ways. We will need to be nimble in responding to incoming data and the evolving outlook.”

For now, however, Powell said the Fed was proceeding as planned to tighten monetary policy in response to inflation that has hit levels not seen in 40 years.

“We will proceed carefully as we learn more about the implications of the Ukraine war on the economy,” Powell said in his testimony. “We have an expectation that inflation will peak and begin to come down this year. To the extent inflation comes in higher or is more persistently high … we would be prepared to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings.”

The Fed slashed rates in 2020 to blunt the impact of the coronavirus pandemic, but there is now broad agreement that the current level of borrowing costs is out of phase with an economy that has rebounded faster than expected from the crisis.

The central bank’s exit plan seemed straightforward, until the outbreak of a land war in Eastern Europe raised a host of new risks, from even higher inflation, to slower growth and the possibility of stress in financial markets should the conflict broaden or conditions deteriorate.

Lawmakers peppered Powell with questions about the effect of rising oil prices, cyberattack threats to the financial system, the broader risks to the financial system, and even the impact on the market for fertilizer due to the Russian invasion.

“Everything we can do … we are doing it,” to protect against a cyberattack, Powell said. “The larger financial institutions are doing it. It’s hard to say what’s possible, but we are on high alert and will continue to be.”

Regarding financial markets, Powell said that so far they have been “functioning well. There is a great deal of liquidity out there,” and existing Fed programs were helping.

Powell will appear before the Senate Banking Committee on Thursday. The Fed chief is required to testify to those House and Senate committees twice a year as part of the central bank’s semi-annual reviews of monetary policy.

Major U.S. stock indexes were trading sharply higher, extending their gains during Powell’s testimony, and yields on Treasuries rose. The U.S. dollar jumped against a basket of major trading partner currencies.

“He preferred to keep the Fed’s options open … there was little pushback on current market rate expectations, which have plummeted since Russia’s invasion,” said Paul Ashworth, chief U.S. economist at Capital Economics.

In his testimony, Powell reiterated the core Fed narrative that high inflation, which is running at about three times the central bank’s 2 per cent target, and an “extremely tight” labour market warrant higher interest rates.

The pandemic’s impact on the economy appeared to be easing, he told the House lawmakers, hiring remains strong, and inflation remains the main risk to the economic expansion.

Inflation “is now running well above our longer-run objective of 2 per cent, Powell said, noting that demand is strong, and bottlenecks and supply constraints are limiting how quickly production can respond.” He added that those supply disruptions had been “larger and longer lasting than anticipated,” and restated the Fed’s promise to be as tough as necessary to bring prices back into line.

While some of those current inflation pressures are expected to ease later this year, “we are attentive to the risks of potential further upward pressure … We will use our policy tools as appropriate to prevent higher inflation from becoming entrenched.”

Yet Powell also acknowledged the new complexity the Fed faces from events in Europe that have the potential to both add to price pressures but also potentially undercut growth.

The persistently high inflation has surprised Fed policy-makers who thought the run of fast price increases triggered by the pandemic would prove temporary.

Since last fall they’ve been debating what to do about it.

After starting the liftoff in rates at its policy meeting in two weeks, the Fed is expected to continue hiking borrowing costs throughout the remainder of this year.

While high inflation remains the Fed’s prime focus, Russia’s invasion of its neighbour has added a new dimension to policy-makers’ analysis, with the potential to pull monetary policy in opposite directions. A sustained rise in energy prices and new limits around the movement of people and goods, for example, could drive inflation even higher.

But global economic growth may take a hit just as U.S. and European governments were hoping the pandemic was easing to the point that the last restrictions on businesses, schools, and socializing could be dropped.

Should the war in Ukraine grind on or even broaden into a wider conflict, the Fed could be called on to keep global dollar markets stable, a job that might conflict with plans to shrink its asset holdings.

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