An eagle tops the U.S. Federal Reserve building's facade in Washington, July 31, 2013. REUTERS/Jonathan Ernst

WASHINGTON, Feb 25 (Reuters) - The Federal Reserve warned Friday that inflation could persist longer than expected if labor shortages and fast wage increases continue, casting aside its prior faith in "transitory" inflation to paint a more cautionary view of how the U.S. economy may evolve.

In the Fed's latest monetary policy report to Congress, delivered twice a year, the Fed said that price increases had broadened since last year and the forces driving them were no longer limited to supply chain issues that might be quickly and easily resolved.

Rather, U.S. labor shortages and the associated rise in wages were also at work, and if those don't ease then inflation may prove more persistent.

While saying that some pressure on goods price could still ease in coming months as supply distribution improves, "if labor shortages continue and wages rise faster than productivity in a broad-based way, inflation pressures may persist and continue to broaden out," the Fed report said.

Fed Chair Jerome Powell will discuss the latest report in congressional hearings next week, where he is likely to be questioned closely about inflation. New data released Friday showed the Fed's preferred inflation index rose 6.1% through January, triple the 2% level targeted by the Fed.

To combat rising inflation, the Fed has signaled it will start raising interest rates next month.

"With appropriate policy, inflation is expected to decline over the course of the year," the report notes, even as it flagged reasons for caution.

The Fed acknowledged, for instance, that elevated inflation, initially concentrated in goods prices, has broadened into services, driven by "strong wage growth in some service sectors and a significant increase in housing rents."

Productivity gains accelerated during the pandemic due to new business formation, widespread use of work-from-home technology and increased automation, the report noted.

All else equal, increasing output per worker should reduce inflationary pressures. But the report also said it was unclear if the trend would last in part because people can try extra hard only for so long.

"Worker effort, which surged in response to employment shortages and hiring difficulties, appears to be elevated, possibly above sustainable levels," the Fed said.

Reporting by Howard Schneider, Lindsay Dunsmuir, Ann Saphir Editing by Chizu Nomiyama and Andrea Ricci

Source: Reuters

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