Jerome Powell, chairman of the US Federal Reserve, spoke at the Brookings Institute regarding ... [+] inflation and the broader economy on November 30. Photographer: Al Drago/Bloomberg

Fed Chair Jerome Powell made clear in a recent speech that services inflation is what concerns him most. He is cautiously optimistic that goods prices will continue to come down and that housing costs will moderate into 2023, but he worries that services costs will continue to follow wage costs higher.

Still, he believes that rates are now close to restrictive levels, so slowing the pace of hikes and holding rates high until inflation is clearly coming down are part of effective management of the uncertainty around inflation, in Powell’s view. This makes a 0.5 percentage point hike when the Fed next sets rates on December 14, highly likely.

Powell spoke extensively at the Brookings Institution on November 30 about monetary policy and the U.S. economy. He first presented on inflation trends for the U.S. economy and then took questions. Markets have viewed his comments favorably, confirming that the U.S. economy is relatively close to peak interest rates.

He explained that U.S. inflation forecasts have been wrong for 12 months now. Many have expected inflation to fall, but it has moved “stubbornly sideways”. That’s why Powell is unwilling to declare victory on inflation after the positive release we saw in the October CPI numbers. He mentioned that there have been a number of months where inflation dropped, only to rebound the next month. That raises the importance of the CPI numbers for December, as nowcasts suggest inflation could rebound.

Powell gave a strong hint that at the Fed’s December meeting the Fed will raise rates by 0.5 percentage points. This is not because the Fed is satisfied that inflation is under control, but more because rates are almost where the Fed wants to see them after a series of hikes over past months.

Powell was candid that the Fed does not know precisely where peak interest rates should be, so moving more slowly on rates as that point approach appeared a prudent risk-management strategy.

Powell shared that one metric he is watching very closely is wage inflation. He sees a clear imbalance in the U.S. jobs market as demand outstrips supply, in part as many older workers left the workforce during the pandemic and have not returned.

This is pushing up wages, which in turn, is driving up service prices in Powell’s view. For example the Atlanta Fed’s wage growth tracker has wages up 6.4% for the year to October 2022.

Powell is not ready to step back from the inflation fight after a positive month of CPI data. He expects the Fed to continue to keep rates high until it is clear that inflation is trending back to the Fed’s 2% target. That means another hike in December and holding rates at high levels until inflation data is a lot more encouraging.

He will be watching wage inflation closely, since he is more confident that the costs of goods and housing are starting to decline. Still Powell’s tone is softening compared to the Jackson Hole speech he gave in late summer. The battle with inflation may not be over, but rate hikes may be coming to an end in the coming months.