The Federal Reserve raised its benchmark interest rate by half a percentage point on Wednesday, signaling its intention to continue squeezing the US economy next year, as central banks on both sides of the Atlantic enter a new phase in the fight against inflation.
At its final meeting of the year, the Federal Open Market Committee voted unanimously to raise the federal funds rate to a target range of 4.25 percent to 4.5 percent, ending a months-long streak of 0.75 percentage point rate hikes.
The pivot to smaller rate hikes is likely to be followed internationally, with the European Central Bank and the Bank of England both poised to raise borrowing costs by half a percentage point on Thursday.
Economists say inflation has peaked in all three regions, with key interest rate cuts in the US and UK this week, but central banks remain concerned it will take too long to fall towards their 2 per cent targets.
In a press conference after the decision, Fed Chair Jay Powell said: “We have covered a lot of ground, and the full effects of our rapid tightening so far have yet to be felt. We have more work to do.”
Powell welcomed the reduction in headline inflation in October and November, but warned “significantly more evidence will be required to give confidence that inflation is on a sustained downward path”[ads1];.
In its statement, the Fed said “ongoing increases” in its key interest rate would be “appropriate” to ensure it supports the economy enough to bring inflation under control.
Trading was choppy after the statement and Powell’s press conference. The S&P 500 closed 0.6 percent lower and the Nasdaq Composite fell 0.8 percent. The two-year government interest rate, which moves with interest rate expectations, was flat at 4.2 percent.
Jay Barry, co-head of U.S. interest rate strategy at JPMorgan, said that before the decision, investors had debated whether the Fed would drop the “ongoing hikes” language in favor of something more dovish.
Sticking with the phraseology “suggests we are several meetings away from the tightening cycle”, Barry added.
Alongside the rate decision, the Fed published a revised “dot plot” of officials’ individual rate projections, which indicated support for further tightening next year.
The median estimate for the fed funds rate at the end of 2023 rose to 5.1 percent, up from the peak of 4.6 percent estimated the last time estimates were published in September. It suggests a rate increase of a total of 0.75 points still to come.
Most officials now see the key rate falling to 4.1 percent in 2024 and 3.1 percent in 2025. That compares with 3.9 percent and 2.9 percent respectively three months ago.
However, Powell noted that Fed officials had consistently raised their forecasts for peak interest rates and warned: “I can’t tell you with certainty that we’re not going to raise our estimate . . . again.”
A large group of policymakers expected the key rate to exceed 5.25 percent next year, with only two saying it would peak below 5 percent.
Asked about the potential for rate cuts next year, as expected by traders in Fed Funds futures, Powell said the Fed was not yet thinking about easing.
“I would not see us considering interest rate cuts until the committee is confident that inflation is moving down to 2% in a sustained manner. That’s the test,” he said, adding that the dot plot suggests no easing in 2023.
Policymakers raised their forecast for inflation next year, with the median estimate for the core price index for personal consumption expenditures — their preferred inflation gauge — rising to 3.5 percent, compared with 3.1 percent in September.
By 2024, most officials expect it to have fallen to just 2.5 percent, still above the central bank’s target. It is estimated to decrease to 2.1 percent the following year.
The politicians were more depressed about the prospects. The economy is set to grow by just 0.5 percent in 2023 before registering an expansion of 1.6 percent in 2024 as unemployment peaks at 4.6 percent.
In September, most officials forecast economic growth of 1.2 percent for 2023 followed by a 1.7 percent increase in 2024, with the unemployment rate at 4.4 percent.
The December meeting marks an important juncture for the Fed, which this year embarked on its most aggressive attempt to tighten monetary policy since the early 1980s.
As the central bank’s actions have begun to have a noticeable impact on the economy, a debate has arisen about how much more restraint is needed to tame inflationary pressures that remain high in many sectors.