Inflation is likely to drop to around 2.5% this year, much closer to the Federal Reserve’s longer-run target of 2% than this year’s rate over 5%, said New York Fed President John Williams, on Friday.
“With growth slowing and supply constraints gradually being resolved, I expect inflation to drop to around 2.5% this year,” Williams said in remarks to the Council of Foreign Relations.
The Fed’s favorite inflation gauge, the personal consumption expenditure price index, was up 5.7% in the year to November, the fastest rate since 1982. Williams said the inflation rate will sink even closer to 2% in 2023.
Williams is a key ally of Fed Chairman Jerome Powell. While other Fed officials have backed a first interest rate hike starting in March, Williams was more circumspect, saying only that he expects a gradual rise in the Fed’s benchmark rate from its current very-low level back to “more normal levels.”
How high the Fed will eventually have to raise interest rates depends on the data, Williams told reporters after his speech.
“In terms of how many rate increases it takes – my baseline view… is really this is about a path of getting us back to more normal interest rate, which I would view as somewhat above 2% down the road,” he said, adding that moving interest rates up to that level could come over the next year or two.
In a similar vein, Williams said the exact timing of when the Fed would start to shrink its balance sheet, and the pace of the run down, depended on the outlook.
Fed officials have penciled in three rate hikes this year. In December the central bank set a plan to end its purchases of Treasurys and mortgages in mid-March.
Williams also pushed back on the view of some market participants that the Fed won’t be able to raise rates very high before the yield curve inverts. He said he expects the long-end of the yield curve to steepen once the Fed starts to move.
In his remarks, Williams said he expects economic growth to slow in 2022 to a 3.5% annual rate from an estimated 5.5% rate last year.
“I expect the current omicron wave to slow growth in the next few months as people once again pull back from contact-intensive activities,” Williams said.
The new omicron COVID variant will temporarily prolong and intensify labor supply challenges and supply-chain bottlenecks.
“But, once the omicron wave subsides, the economy should return to a solid trajectory and these supply constraints on the economy should ebb over time,” he added.
At the same time, Williams said he expects the unemployment rate will come down further to 3.5% this year from 3.9% in December. The labor market was “quite strong,” he said.