Yellen Says Fed Will Continue Path of Gradual Rate Increases -- 3rd Update

By Nick Timiraos Features Dow Jones Newswires

Federal Reserve Chairwoman Janet Yellen on Wednesday said the U.S. central bank would continue with its path of gradual increases in short-term interest rates because the economy is performing mostly in line with its expectations.

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But she offered few specific signals about what the Fed will do at its meeting next month or how it could alter its policy plans next year if Congress approves tax cuts that stimulate growth.

Fed officials have done little to push back against market expectations of an increase in the Fed's benchmark federal-funds rate at its Dec. 12-13 meeting. Fed governor Jerome Powell, who has been nominated to succeed Ms. Yellen next February, told lawmakers Tuesday the case for a rate increase next month "is coming together."

A rate increase next month would be the Fed's fifth such move in two years and would lift the rate to a range between 1.25% and 1.50%.

Ms. Yellen offered a mostly upbeat assessment of the economy's performance during the second half of this year, particularly because an unemployment rate at 4.1%, a 17-year low, is helping to draw more workers into the labor force. The big puzzle for the Fed has been surprising softness in inflation readings. Excluding energy and food categories, the Fed's preferred inflation gauge rose 1.3% in September from a year earlier, below the central bank's 2% target.

"Wage increases are modest," Ms. Yellen told lawmakers on the Joint Economic Committee. One lesson from that, she said, is "the labor market and the economy are not significantly overheated in spite of the fact that we have a very low unemployment rate."

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Ms. Yellen repeated her view that recent low readings in consumer price growth "likely reflect transitory factors" and that as those factors fade, inflation will stabilize around the 2% target. But she also nodded more firmly to the uncertainty around her expectation. "It is also possible that this year's low inflation could reflect something more persistent," she said.

Fed officials look prepared to raise interest rates in part because labor markets continue to tighten. The unemployment rate has fallen below the level Fed officials believe is sustainable over the long run, and the economy appears to be growing ahead of its potential, even before Congress considers tax cuts that could propel growth higher next year.

Ms. Yellen faced questions from lawmakers Wednesday morning over how the Fed might react to any boost in demand or consumption from tax cuts being considered by Republican lawmakers given that the unemployment rate suggests there is much less slack in the economy than in recent years.

"We welcome strong growth. The Fed is not trying to stifle growth," she said. "We're worried about trends that could push inflation above our 2% objective."

The House of Representatives earlier this month approved a tax overhaul package, and the full Senate is set to consider its tax legislation in the coming days. A forthcoming report from the nonpartisan arm of Congress that analyzes tax legislation, the Joint Committee on Taxation, will assume the Fed responds aggressively to counter the effects of any tax cut.

Fed officials "don't have some cap on growth that we're trying to achieve," Ms. Yellen added. But given the tight labor market, higher growth will need to be accompanied by stronger productivity to avoid an unsustainable rise in inflation, she said.

Ms. Yellen encouraged Congress to consider legislation that could boost the productivity of the workforce and increase workforce participation, including policies that encourage business investment, capital formation, infrastructure and education.

"To generate a sustained boost in economic growth without causing inflation that is too high, we will need to address these underlying causes" of weak productivity and slower labor-force growth, she said.

In addition to raising rates twice this year, the Fed set into motion last month its strategy to slowly shrink its $4.5 trillion portfolio of bonds and other assets. Ms. Yellen said the runoff of that balance sheet has proceeded smoothly so far, and the Fed doesn't foresee any need to alter the program.

Ms. Yellen didn't signal significant concern about potential financial imbalances in her testimony. While asset valuations "are high by historical standards," she said the financial sector doesn't look particularly vulnerable because the banking system is better capitalized and leverage and debt growth "remain contained."

The Fed held rates near zero for seven years after the 2008 financial crisis, but with rates now farther away from that low point, the big question in the coming year is how much higher the central bank will need to lift them.

Ms. Yellen in her testimony Wednesday said the neutral rate, at which the Fed is neither trying to slow down nor speed up growth, appears to be "quite low by historical standards," which would mean interest rates don't have much farther to rise. Still, she said most Fed officials expect that neutral rate to rise somewhat over time, meaning additional gradual rate increases "would likely be appropriate over the next few years to sustain the economic expansion."

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

(END) Dow Jones Newswires

November 29, 2017 11:39 ET (16:39 GMT)