The Federal Reserve is set to shift to lower interest rate rises on Wednesday but signal it will keep squeezing the US economy next year, as central banks on both sides of the Atlantic enter a new phase in their battle against inflation.
The Fed is poised to lift the federal funds rate half a percentage point at its final gathering of the year to a new target range of 4.25 per cent to 4.5 per cent, ending a months-long string of 0.75 percentage point rate increases.
The pivot to smaller increases in interest rates is likely to be followed internationally, with both the European Central Bank and the Bank of England also poised to increase borrowing costs by half a percentage point on Thursday.
Economists maintain that inflation has peaked in all three regions — highlighted by falls in the headline rate in the US and UK this week — but central banks remain worried that it will take too long to fall towards their 2 per cent targets.
The recent drops in inflation have been caused by large increases in oil and goods prices last year falling out of the annual comparison.
In the US, Fed officials’ concerns about the persistence of above-target inflation are likely to result in higher projections for future interest rates compared with their previous estimates published in September, when most estimated a peak of 4.6 per cent.
On Wednesday, the “dot plot” of individual forecasts is set to show the fed funds rate hitting between 4.75 per cent and 5.25 per cent, with a sizeable cohort favouring the higher end of that range.
Most officials will signal that they do not expect rate cuts until 2024, indicating that interest rates should be kept high for some time to curb demand and alleviate inflationary pressures.
The Fed’s rate decision and latest projections will be published at 2pm Eastern Time, followed by a press conference with chair Jay Powell. They come on the heels of the US’s latest inflation figures, which showed consumer price growth easing more than expected in November, a development replicated in European data.
Powell has previously said it will take “substantially more evidence” than a single month’s data for the Fed to be confident inflation is actually declining, noting past periods when better than expected data were followed by fresh increases.
Fed officials are expected on Wednesday to revise their 2023 forecasts downwards for the core personal consumption expenditures price index — their preferred inflation gauge. In September, the median estimate was 3.1 per cent in 2023 and 2.3 per cent in 2024.
The Federal Open Market Committee will debate the key issue of how much more to restrain the US economy, given signs that their actions so far — the most aggressive attempt to tighten monetary policy since the early 1980s — are starting to have a more noticeable effect.
US home prices have fallen from their recent peak as mortgage rates have surged, the manufacturing sector is flagging and consumer sentiment remains low.
However, the labour market continues to show surprising resilience. The unemployment rate still hovers at a historically low level of 3.7 per cent and wages have risen rapidly amid an acute worker shortage, accelerating to a pace officials warn risks igniting yet more price pressures.
FOMC members and other Fed officials are also poised to revise their forecasts for growth lower and raise their unemployment rate projections in light of the further rate rises to come.
In September, most predicted 0.2 per cent economic growth for 2022 followed by a 1.2 per cent increase in 2023, with the unemployment rate peaking at 4.4 per cent.
Powell recently said it was “very plausible” that the Fed could bring down inflation without causing a recession. New polling conducted by the Financial Times suggests doubts about that outcome, however. Of the economists surveyed, 85 per cent expect a recession next year.
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