WASHINGTON – Federal Reserve officials on Wednesday made their eighth rate hike in a year and signaled at least two more to come as they continue their battle against rapid price increases. But they approved a smaller increase than previously and acknowledged that inflation had finally started to slow down meaningfully.
The central bank ended its first meeting of 2023 by announcing a quarter-point interest rate hike, the smallest adjustment since March. The Fed’s key interest rate is now set at a range of 4.5 to 4.75 percent, up from near zero a year ago.
Wednesday’s move marked a major slowdown from last year, when the Fed raised borrowing costs at the fastest pace since the 1980s in an attempt to curb rising inflation. Price increases have now slowed, with the Fed’s preferred inflation index on 5 percent in December, down from a high of almost 7 percent in June.
With interest rates already elevated, central banks are gradually adjusting policy as they wait to see how their higher borrowing costs affect consumers and businesses. Incoming economic readings will help determine how high the Fed ultimately raises interest rates and how long it keeps them there.
Fed Chairman Jerome H. Powell made it clear during his press conference on Wednesday that the central bank planned to be cautious in declaring victory over inflation. He said “a few more” rate hikes were under discussion to ensure price pressures came firmly and fully back under control.
“We can now say, for the first time, that the disinflationary process has started,” Mr Powell said, but he later added: “We will stay the course until the job is done.”
Despite that, Wall Street welcomed Mr Powell’s remarks as a sign that the Fed may stop raising interest rates very soon – after March. Stocks rose as he spoke on expectations that the central bank will end its adjustments after another rate move solidified. Market prices also suggested that investors had increased the chances that the Fed would cut interest rates especially by the end of the year. The S&P 500 rose 1 percent, adding to a rally that has lifted stocks more than 7 percent this year.
The disconnect between the Fed’s statements and investors’ expectations is partly down to what is actually happening in economic data versus what is expected to happen next. Many forecasters expect the labor market, as well as inflation in many types of services, to weaken this year as the full impact of the Fed’s interest rate moves play out; The Fed, on the other hand, is waiting for clearer signs in the data.
The Fed’s decision signaled a shift to a more cautious period of inflation control. Its policymakers welcome the recent slowdown in price increases, and the disinflationary trend gives them more room to tread carefully as they make further policy adjustments. But central bankers worry that some of today’s inflation may prove difficult to eradicate entirely, preventing them from stopping the onslaught entirely.
“We have moved into a new phase of policy,” said Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives. “The committee no longer plays a role in the field.”
Central bankers projected in December that they would raise interest rates to just above 5 percent in 2023 — implying another two quarter-point increases after this week’s move — and leave them there through the year. These higher borrowing costs would make it more expensive to finance a car or expand a business, curbing demand and helping bring the economy back into balance.
Officials reiterated in their statement Wednesday that “ongoing” rate hikes would likely be appropriate. But Mr Powell said no decisions had yet been made on how high prices would go.
At times, Mr Powell hinted that the central bank still expected to raise interest rates to just above 5 per cent and then leave them there throughout 2023.
“We’re talking about a few more rate hikes to get to the level we think is appropriately restrictive,” he said. He later added that he did not expect to cut interest rates this year if the economy performed as expected.
Sir. Powell also noted that he did not “feel a lot of certainty” about where rate hikes would stop and that “it could certainly be higher,” saying it was difficult to manage the risk of doing too little and causing inflation to jump back up. On the other hand, he said that if the Fed went too far, it would be easier to deal with.
“The task is not quite finished,” he said.
So far, evidence that labor market moderation in particular is not decisive: Initial claims for unemployment benefits remain muted and unemployment is as low as it has been in half a century. The number of job vacancies increased in December, and 1.9 positions are now available for every unemployed worker.
“The labor market remains extremely tight,” Mr Powell said on Wednesday. The Ministry of Labor publishes employment and unemployment figures for January on Friday.
That creates a source of tension for the Fed. Officials had always expected prices to begin to cool as pandemic supply chain problems were resolved and consumers worked through large savings stocks and slowed their spending — and that slowdown is showing. But some policymakers worry that rapid wage growth could keep inflation in services — hotels, restaurants, sporting events — stubbornly higher than it was before the pandemic.
“We saw a recognition that the inflation picture is improving, but that doesn’t mean the Fed is in any way close to declaring victory on that,” said Sarah House, senior economist at Wells Fargo.
The global economy is also not as weak as many expected, as a mild winter mitigates energy-related problems in Europe and as China reopens from rolling shutdowns. In their statement, Fed officials nodded to the fact that worldwide growth is less threatened than it appeared last year, dropping a line that said the war in Ukraine was “weighing on global economic activity.”
Instead, Fed policymakers said the war “contributes to increased global uncertainty.”
Such signs of economic resilience could help the Fed pull off a soft landing, where it tames inflation without causing a deep downturn. On the other hand, continued economic strength could bolster demand and prevent price increases from easing sufficiently if growth proves too robust.
Fed officials will be focused on where the economy is headed — and how much more they think it needs to slow down — in the coming months as they decide how high to raise interest rates and for how long to keep them elevated .
How much more the Fed ultimately does will matter to Americans everywhere because it will help determine how much unemployment rises this year.
“The risk of a recession is very real at this point,” said Bill English, a former director of the Fed’s monetary affairs division who is now a professor at the Yale School of Management. “They walk pretty close to the line somehow.”
Beth Ann Bovino, chief U.S. and Canada economist at S&P Global Ratings, said the Fed’s plan to reduce the size of rate hikes indicated that central bankers are “trying to land the plane with grace.”
But she added that “the impact of cumulative rate hikes comes with a lag.”
From their latest economic forecasts, central bankers expected the unemployment rate to rise to 4.4 percent by the end of the year. It would be up from 3.5 percent now. The central bank will publish its next set of economic projections in March.
Mr. Powell said he believed the Fed would be able to fight inflation without plunging the economy into a painful recession. But he also reiterated that the central bank was committed to bringing price rises under control, despite the potential costs to growth and the labor market.
“We have to complete the task,” he said. “That’s what we’re here for.”
