Yellen: Inflation Should Rebound, but Fed Could Alter Policy if Softness Persists -- 3rd Update

Federal Reserve Chairwoman Janet Yellen, seeking to address a recent puzzling slowdown in global inflation, said she expects 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.

But she left herself an out, saying the Fed would alter its plans if softer price pressures proved more persistent.

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

Fed officials next meet July 25-26. At their meeting last month, officials raised rates for the third time in as many quarters to a range between 1% and 1.25% and penciled in one more rate increase this year. Ms. Yellen gave no indication about the timing of the next rate increase in her testimony Wednesday.

Ms. Yellen also updated lawmakers on the Fed's plans to start slowly shrinking its $4.5 trillion portfolio of bonds and other assets acquired during and after the 2008 financial crisis. Ms. Yellen said she expected to set those plans into motion "relatively soon" this year, but wasn't more specific about the timing.

Ms. Yellen faces two days of testimony, with the House panel Wednesday and the Senate Banking Committee on Thursday, in what could be her final appearances on Capitol Hill 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.

Ms. Yellen demurred when asked repeatedly about her desire to serve a second term. "I really haven't had to give further thought at this point to this question," she said.

Statements from Fed officials in recent weeks have highlighted a debate over whether a slowdown in inflation should lead them to hold back on additional rate increases for now. But even those who want to go slower on raising rates because of their inflation doubts have shown no such qualms about announcing plans to implement the portfolio runoff in the next few months.

Excluding 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. In her testimony, Ms. Yellen said the inflation slowdown partly reflects unusual one-off declines and officials would monitor inflation developments closely in the months ahead. "There is...uncertainty about when -- and how much -- inflation will respond to tightening resource utilization," she said.

Her remarks Wednesday indicated slightly greater uncertainty about the forces slowing price growth than her comments at a press conference following the decision to raise interest rates last month. Ms. Yellen said Wednesday the recent slowdown "partly" reflected one-off factors, while she said they "significantly" reflected such factors last month. Stocks rallied and bond yields fell after her testimony Wednesday morning.

Ms. Yellen's tenure as Fed chairwoman began in early 2014, as the Fed began to slow its purchases of Treasury and mortgage securities, the conclusion of the latest -- and broadest -- effort to spur household and business investment by pushing down long-term interest rates.

The Fed stopped adding to its holdings, also known as its balance sheet, in October 2014, but it has continued to reinvest the proceeds of maturing assets to maintain the portfolio's size. Since then, central bankers in Europe and Japan have ramped up similar bond-buying experiments, and the Fed slowly moved to raise interest rates from near zero.

Under the balance-sheet plan announced last month, the Fed will allow its holdings to decline gradually by allowing a predetermined amount of bonds to mature every month without reinvestment. Allowing some of the holdings to run off could push up long-term rates, but markets haven't shown a significant reaction so far.

The Fed doesn't plan to use its portfolio as an active tool of monetary policy during normal times, Ms. Yellen said Wednesday. But it would be "prepared to resume reinvestments if a material deterioration in the economic outlook were to warrant a sizable reduction in the federal-funds rate," she said.

More broadly, Ms. Yellen said the economy's performance was likely to warrant "gradual increases in the federal-funds rate over time" to achieve the Fed's goals of maximum sustainable employment and stable prices, measured relative to a 2% annual inflation target. Inflation has fallen below that target for most of the last five years.

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 speed up or slow down the economy. Because that level is currently low by historical standards, "the federal-funds rate would not have to rise all that much further to get to a neutral policy stance," she said.

Ms. Yellen's outlook on the economy was little changed from the assessment she offered at a news conference last month after the Fed announced its most recent rate increase. The unemployment rate, at 4.4% in June, is near its lowest levels in 16 years.

Some Fed officials in recent weeks have said easier financial conditions, including stocks at record highs and a decline in the dollar, could justify further rate increases this year. Ms. Yellen didn't mention financial conditions in her prepared testimony.

Ms. Yellen is likely to face questions over financial regulation at Wednesday's hearing. While she has largely defended the postcrisis financial-regulatory architecture created by the Dodd-Frank Act, Ms. Yellen and other Fed officials have signaled openness to changing some of those rules.

On Tuesday, the White House formally nominated Randal Quarles, a former Treasury official in Republican administrations, to serve on the Fed's seven-member board of governors and as the vice chair of bank supervision, a new post created by the 2010 Dodd-Frank financial-regulatory overhaul. The Fed has two other vacancies on its board, giving Mr. Trump an early opportunity to put his stamp on the central bank.

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

WASHINGTON -- 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.

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.

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)