WASHINGTON (CN) – Two days before United Kingdom citizens vote on whether to stay in the European Union, Federal Reserve Chairwoman Janet Yellen warned of potentially significant repercussions to the economy if Britain leaves.
During her report on monetary policy to Congress on Tuesday morning, Yellen defended the Federal Reserve’s decision last week to keep its key interest rate low and assured Congress it will rise again once “headwinds” slow.
One such headwind could be the scheduled “Brexit” vote Thursday, when the United Kingdom decides whether to remain a part of the European Union. Polls on the referendum have tightened in recent weeks, showing a narrow advantage for voters who want to stay over those keen on leaving.
While Yellen said in her report to Congress that the U.S. economy has “moderate” financial vulnerabilities, she warned a shakeup in the European Union could spook markets and increase the risk of instability.
“It would be significant for the United Kingdom and for Europe as a whole,” Yellen told the Senate Committee on Banking Housing and Urban Development. “I think it would usher in a period of uncertainty and it is very hard to predict. But there could be a period of financial market volatility that would negatively affect financial conditions and the U.S. economic outlook. That’s by no means certain but it is something that we will be carefully monitoring.”
While she said it is unlikely a British flight from the European Union will plunge the U.S. economy back into recession, she acknowledged the vote is a “unique event that has no real parallel,” leaving the Federal Reserve uncertain about how the ripples of such a vote could upset markets at home.
“I don’t think that’s the most likely case but we just don’t really know what will happen and we’ll have to watch very carefully,” Yellen said.
Yellen’s report to Congress focused primarily on the state of the U.S. economy and the Federal Reserve’s path forward on its key interest rate, which it raised for the first time since 2006 in December. Though the central bank originally indicated it would gradually increase the rate, it held it stagnant last week instead.
While some lawmakers, like Committee Chairman Sen. Richard Shelby, R-Ala., questioned whether the Fed’s decision to keep interest rates low would have a major negative impact on the economy, Yellen defended the decision.
“I believe that persistently low interest rates we’ve had have been essential to keeping the progress,” Yellen told Shelby.
She said lower than expected economic growth and low inflation spurred in part by dropping energy prices forced the Federal Reserve to hold off on bumping up interest rates. In addition to these problems, Yellen lamented “surprisingly weak” business investment and a slow labor market.
These trends could come together to cause the Federal Reserve to hold back on a rate hike in the future as well, Yellen said, though she is “optimistic” about growth in the labor market and the economy as a whole over the “next few years.”
“The committee expects that economic conditions will evolve in a manner that will warrant only gradual future increases in the federal funds rate, and that the federal funds rate will likely remain, for some time, below levels that are expected to prevail in the longer run,” Yellen wrote in her report to Congress.
Inflation, which the Federal Reserve would like to see hold steady at 2 percent, will rise in the “medium term,” Yellen predicted, which could free up the Federal Reserve to bump up interest rates.
But the path of the key rate will depend on a number of factors the Federal Reserve is monitoring, not just one catch-all indicator, she said.
“The actual path of the federal funds rate will depend on economic and financial developments and their implications for the outlook at associated risks,” Yellen said.
“Stronger growth or a more rapid increase in inflation than the committee currently anticipates would likely make it appropriate to raise the federal funds rate more quickly.”
Federal Reserve Chairman Janet Yellen arrives on Capitol Hill in Washington, Tuesday, June 21, 2016, to testify before the Senate Banking Committee. Yellen said the U.S. economy faces a number of uncertainties that require the Fed to proceed cautiously in raising interest rates. (AP Photo/Evan Vucci)
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