Yellen: Inflation Should Rebound, but Fed Could Alter Policy if Softness Persists -- 5th Update

By Nick Timiraos Features Dow Jones Newswires

Federal Reserve Chairwoman Janet Yellen, faced with a recent, puzzling slowdown in global inflation, said she expects the forces holding down consumer prices to fade in the months ahead, allowing the central bank to stick to its plans for gradual interest-rate increases.

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But she left herself an out, saying the Fed could veer from its policy plans if inflation weakness proved more stubborn than officials expect.

Ms. Yellen repeated her view that a tightening labor market would put upward pressure on wages and prices. "It's premature to reach the judgment that we're not on the path to 2% inflation over the next couple of years," she said Wednesday during a hearing of the House Financial Services Committee. But, she added, "We're watching this very closely and stand ready to adjust our policy if it appears that the inflation undershoot will be persistent."

Stocks rallied and bond yields fell after her testimony.

Markets increasingly expect the Fed to next raise rates in December, after launching in September the process of slowly shrinking its $4.5 trillion portfolio of bonds and other assets acquired during and after the financial crisis.

Fed officials next meet July 25-26. At their meeting last month, they raised short-term interest rates for the third time in as many quarters to a range between 1% and 1.25% and penciled in one more increase this year.

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Fed officials in recent weeks have debated whether the inflation slowdown is likely to pass or persist, with some saying they want to hold off on more rate increases until price pressures pick up. But even those who want to go slower on raising rates because of inflation have shown no such qualms about announcing plans to implement the portfolio runoff in the next few months.

Ms. Yellen has been in the camp of those who see the inflation slowdown as likely to be transitory.

She told lawmakers the traditional pattern in which tighter labor markets put pressure on wages and inflation more broadly have been slow to surface. "The relationship between those two things has become more attenuated than we've been accustomed to historically," she said. The unemployment rate, at 4.4% in June, was near its lowest level in 16 years, but wage pressures have been muted.

"There is...uncertainty about when -- and how much -- inflation will respond to tightening resource utilization," Ms. Yellen said Wednesday.

Excluding the volatile food and energy categories, the Fed's preferred inflation gauge slowed to a gain of 1.4% over the year ended May, versus 1.8% in February -- both below the Fed's 2% target. The Labor Department is set to report on its consumer-price index for June on Friday.

While some Fed officials in recent weeks have said the Fed should hold to its plans to raise rates despite low inflation, because of the strong labor market and easier financial conditions, Ms. Yellen offered few signs of alarm about the possibility of loftier asset prices creating financial instability.

Ms. Yellen characterized the Fed's benchmark short-term rate as "somewhat below" its neutral level, one in which the Fed is neither trying to spur nor slow the economy. Because that neutral level is currently low by historical standards, she said the central bank might not need to raise rates much further to reach it.

Ms. Yellen said, as she did in June, that the Fed could pull the trigger on the balance-sheet plan "relatively soon." She added Wednesday that she didn't find the timing terribly important now that the approach is well understood by markets.

Ms. Yellen faces a second day of testimony Thursday, before the Senate Banking Committee, in what could be her final appearances before both panels before her term expires in February. The White House is beginning the process of considering who should be the next Fed leader. While Ms. Yellen isn't expected to be reappointed, President Donald Trump hasn't ruled it out.

Asked repeatedly whether she wants to serve a second term, Ms. Yellen initially demurred and implied she hadn't discussed the matter with the White House. Later, when asked what she would say if Mr. Trump asked her to serve another term, she said, "It is certainly something that I would discuss with the president, obviously."

The hearing also showed how the political dynamic facing the central bank could shift with Republicans in control of the White House and the Fed farther along in plans to raise rates and shrink its balance sheet.

Ms. Yellen's appearance before the House panel was less contentious than prior hearings, in which Republicans unsparingly challenged the central-bank leader over everything from institutional accountability to economic forecasts. Democrats, meanwhile, appeared less willing to offer unconditional support for the Fed's stance toward gradually providing less support to the economy, though many extolled Ms. Yellen's leadership of the central bank.

Write to Nick Timiraos at nick.timiraos@wsj.com

(END) Dow Jones Newswires

July 12, 2017 18:34 ET (22:34 GMT)