washington –
After raising rates by three-quarters of a quarter in four consecutive hikes, the U.S. Federal Reserve will announce on Wednesday that it will raise its key interest rate by a smaller half basis point, the first step in scaling back its efforts to fight inflation.
Meanwhile, the Federal Reserve is expected to signal that it plans to raise interest rates more than it previously forecast next year in an attempt to beat the worst inflation in 40 years. Most economists believe that Fed Chairman Jerome Powell will emphasize that the central bank is likely to keep its benchmark interest rate high until next year even after the rate hikes are over.
The Fed’s decision on Wednesday will follow Tuesday’s government report, which offered hopeful signs that inflation has finally eased from long-term highs. Gasoline prices have fallen, the cost of used cars, furniture and toys has fallen, and the cost of services from hotels to airfare to car rentals has fallen.
The Fed has raised rates six times this year, raising its key short-term rate to a range of 3.75% to 4%, the highest level in 15 years. Cumulatively, the rate hikes lead to higher borrowing rates for consumers and companies, on everything from mortgages to auto and business loans. Fears are growing that the Federal Reserve will raise interest rates so aggressively to curb inflation that it will trigger a recession next year.
However, with price gains still uncomfortably high — year-over-year inflation was 7.1% in November — Powell and other Fed officials have stressed that they expect to keep rates at their peak for an extended period Level.
Still, with inflationary pressures now easing, most economists believe the Fed will slow the pace of rate hikes further at its next meeting early next year, raising its key rate by 25 basis points.
“(Tuesday’s) data sort of fit our idea that the Fed will cut rates further in February,” said Matthew Luzzetti, an economist at Deutsche Bank and a former research analyst at the Fed. “The deceleration helps maximize the prospect of a soft landing,” in which Fed rate hikes would slow growth and curb inflation but not tip the economy into recession.
On Wednesday, members of the Fed’s rate-setting committee will also update their forecasts for interest rates and other economic barometers through 2023 and beyond. Most analysts predict they will forecast a peak range of at least 4.75% to 5%, or even 5% to 5.25%, up from their September forecast of 4.5% to 4.75%.
Despite Powell’s recent hawkish rhetoric — he said late last month that “we’re not seeing significant progress in slowing inflation” — he and other Fed officials have made clear they are ready to slow the pace of rate hikes. In doing so, they will have time to assess the impact of the increases they have implemented. Those increases sent home sales plummeting and started lowering rents for new apartments, a major source of high inflation.
Fed officials also said they want interest rates to reach “restrictive” levels that would slow growth and hiring and bring inflation down to their 2% annual target.
“What policy rates are sufficiently restrictive we can only learn gradually by watching the economy evolve,” said Lisa Cook, one of the seven members of the Fed’s board of governors. “Given that tightening is already on the horizon, I note a long lag in the operation of monetary policy.”
Fed officials have stressed that more important than how quickly they raise rates is how long they keep rates at or near their peak. In September, the Fed forecast rate cuts through 2023. However, Wall Street investors are now betting that the Fed will reverse course and begin cutting rates by the end of next year.
In speeches late last month, Powell said he was tracking price trends in three different categories to best understand the likely path of inflation: commodities, excluding the volatile food and energy costs; housing, including rent and the cost of buying a home and services that do not include housing, such as auto insurance, pet services, and education.
In his speech, Powell noted that some progress had been made in easing inflation in goods and housing, but not in most services sectors. Some of those trends carried over to last month’s data, with commodity prices excluding food and energy falling 0.5% from October to November, the second straight monthly decline.
Housing costs, which account for nearly one-third of the consumer price index, are still rising. But at the height of the pandemic, real-time indicators of apartment rents and home prices began to decline after posting a stunning acceleration in prices. Those declines, likely to show up in government data next year, should help lower headline inflation, Powell said.
As a result, Powell is most concerned about the services sector, which he said is likely to remain elevated. Part of the reason is that sharp increases in wages are becoming a major factor in inflation. Service companies, such as hotels and restaurants, are particularly labor-intensive. With average wages growing rapidly at a rate of 5%-6% per annum, price pressures in this sector of the economy are increasing.
How the Fed will slow down a strong labor market to help bring inflation down could prove dangerous. Powell and other Fed officials have said they hope rate hikes will slow consumer spending and job growth. Businesses would then eliminate many job openings, easing demand for labor. Wage growth may start to slow as competition for workers decreases.
Powell has even proposed a wage target: he thinks about 3.5% annual wage growth is compatible with 2% inflation. Currently, the average salary increases by about 5%-6% per year.
Three months ago, Fed policymakers estimated that the unemployment rate would rise to 4.4% next year from the current 3.7%. On Wednesday, policymakers were likely to forecast higher unemployment by the end of 2023. If so, that would suggest they expect more layoffs and a possible recession.