Powell Says Supply-Side Constraints Have Worsened, Creating More Inflation Risk

While the Fed has anticipated that price pressures would abate as the pandemic subsides, Mr. Powell said it would be important for the central bank to stay flexible in the months ahead. The central bank will “need to make sure that our policy is positioned for a range of possible outcomes.”

Rising vaccination rates and the nearly $2.8 trillion in federal spending approved since December 2020 have produced a recovery like none in recent memory. Inflation has soared this year, with “core prices” that exclude volatile food and energy categories, the Fed’s preferred gauge, up 3.6% in August from a year earlier. The gains largely reflect disrupted supply chains and shortages of labor and materials.

Mr. Powell and his colleagues have signaled strongly that the Fed would formally announce a gradual reduction, or tapering, of its monthly purchases of $120 billion in Treasury and mortgage debt at its Nov. 2-3 meeting. Officials are likely to reduce those purchases by $15 billion a month, allowing them to conclude the bond-buying program by next June.

“I do think it is time to taper,” Mr. Powell said Friday. “I don’t think it is time to raise rates.”

The schedule for phasing out the Fed’s stimulus program is faster than investors anticipated just a few months ago. Officials don’t want to be in a position where they feel compelled to raise rates at a time when they are still fueling monetary stimulus by purchasing assets, and the faster timetable partly reflects how this year’s surge in inflation is lasting longer than central bank officials and private-sector economists anticipated.

In a speech in late August, Mr. Powell detailed five factors that supported his view that recent elevated inflation readings “are likely to prove temporary.” Those included the absence of broad-based inflation pressures as well as an expected slowdown in price increases from items that had experienced high inflation this year, such as used cars and other durable goods.

But at the same time, he concluded his assessment by noting, “We will be looking for evidence that supports or undercuts that expectation.”

Inflation data and a surge in energy prices since September point to some broadening in price pressures, and other central banks have signaled plans to raise rates more aggressively. That has fueled recent bond-market expectations of somewhat earlier and faster rate rises by the Fed.

The probability of at least two interest rate increases by the end of next year has risen above 75%, according to futures market prices tracked by CME Group. At the conclusion of the Fed’s meeting last month, investors saw around a 20% probability of two increases by the end of 2022.

Successfully managing the economic exit from the pandemic remains the greatest challenge facing Fed policy makers, Mr. Powell said. The virus essentially removed a piece of potential economic output—concentrated in high-contact service sectors, such as leisure, hospitality and entertainment industries. Officials “want to give full time for that to come back” before deliberately cooling demand for goods and services more broadly by raising rates, he said.

On the other hand, inflation is running well above the Fed’s 2% goal. “We see that. We know how painful that is” for consumers, Mr. Powell said.

“We think we can be patient and allow the labor market to heal,” he said. But at the same time, “no one should doubt that we will use our tools to guide inflation back down to 2%” if it looked like more persistent inflationary pressures were taking root, Mr. Powell added.

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