Fed see key services inflation elevated with few signs of easing

By Howard Schneider

(Reuters) -Inflation in key parts of the U.S. service industry “remains elevated and has not shown signs of easing,” the U.S. Federal Reserve said in its latest monetary policy report to Congress, an overview of where the economy stands issued ahead of Capitol Hill testimony next week by Fed chair Jerome Powell.

Hopes for the Fed to slow inflation, the report said, “may depend in part on a further easing of tight labor market conditions,” meaning a likely rise in U.S. joblessness.

“Labor demand has eased in many sectors of the economy but

continues to exceed the supply of available workers, with job vacancies still elevated,” the report said. Wages gains had slowed over the first part of the year, but “remain above the pace consistent with 2% inflation over the longer term.”

The report noted that bank lending had “tightened notably” over the past year and would likely contract further following the failure of several regional banks in March.

But “despite concerns about profitability at some banks, the banking system remains sound and resilient,” the report said.

The report, issued ahead of two days of congressional testimony next week by Fed Chair Jerome Powell, comes on the heels of the central bank’s latest policy meeting when it opted not to raise interest rates for the first time since March 2022.

In leaving its benchmark policy rate unchanged in a range between 5.00% and 5.25%, the Fed said the pause would allow it time to “assess additional information and its implications for monetary policy.”

Still, projections from policymakers submitted at the June 13-14 meeting signaled they were prepared to lift rates by perhaps half a percentage point more by year’s end. Investors for now overwhelmingly expect the Fed to resume rate hikes when it meets again in late July.

Indeed, two policymakers on Friday struck a hawkish tone in the first public Fed comments of the intermeeting period.

Friday’s report hit on a now-familiar topic – financial stability – with an acknowledgement that banking system conditions are not as benign as the Fed said they were in March, when it issued its previous report to Congress only days before the surprise collapse of Silicon Valley Bank.

At that time, it said, “financial vulnerabilities remain moderate overall.” SVB failed a week later, forcing the Fed and other banking regulators to take emergency steps to prevent a wholesale run on deposits across the banking system.

On Friday, the Fed said that following actions taken in the wake of the SVB failure “financial markets normalized, outflows

of bank deposits slowed, and the banking system as a

whole remains sound and resilient.

“However, ongoing stresses in the banking sector may weigh on credit conditions in the period ahead and increase uncertainty about the economic outlook.”

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