The Federal Reserve on Wednesday raised its key interest rate by half a percentage point and signaled its intention to keep squeezing the US economy next year as central banks on both sides of the Atlantic enter a new phase in the battle 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% to 4.5%, ending a months-long streak of rate hikes of 0.75 percentage points.
The tilt towards smaller rate hikes is likely to be followed internationally, with the European Central Bank and the Bank of England 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 worried it will take too long to fall to their 2 percent targets .
At a news conference after the decision, Federal Reserve Chairman Jay Powell said: “We have come a long way, and the full effect of our rapid tightening so far is yet to be felt. We still have work to do.”
Powell welcomed the easing of core price growth in October and November, but warned that “significantly more evidence will be needed to give confidence that inflation is on a sustained downward path.”
In its statement, the Fed said “continued increases” in the key interest rate would be “appropriate” to ensure it tightens the economy enough to bring price growth under control.
As Powell spoke at his press conference, U.S. stocks fell to session lows, with the S&P 500 down 0.8 percent and the Nasdaq Composite down 1 percent. The yield on two-year government bonds, which moves with interest rate expectations, rose 0.03 percentage points to 4.2 percent.
Jay Barry, co-head of U.S. interest rate strategy at JPMorgan, said before the decision investors had been discussing whether the Fed would drop the “continued hikes” language in favor of something more dovish.
Sticking with the phraseology “suggests we’re many dates into the tightening cycle,” Barry added.
Along with the interest rate decision, the Fed released a revised “dot plot” of officials’ individual rate forecasts, showing support for further tightening next year.
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The average estimate for the fed funds rate through the end of 2023 rose to 5.1 percent, up from the peak of 4.6 percent forecast when the forecasts were last published in September. That suggests a total of 0.75 basis points for rate hikes still to come.
Most officials now see a rate cut to 4.1% in 2024 and 3.1% in 2025. That compares with 3.9% and 2.9% respectively three months ago.
However, Powell noted that Fed officials have consistently raised their forecasts for peak interest rates and warned: “I can’t tell you with confidence that we won’t raise our forecast. . . again.”
Policymakers raised their forecast for inflation next year, with the average estimate for the core personal consumer price index – their preferred gauge of inflation – rising to 3.5 percent, up from 3.1 percent in September.
In 2024, most officials expect it to fall to just 2.5 percent, still above the central bank’s target. It is forecast to decrease to 2.1 percent next year.
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Reflecting officials’ expectations that they will have to push the economy harder than expected, policymakers were more pessimistic about the outlook. The economy is expected to grow by just 0.5% in 2023 before registering an increase of 1.6% in 2024 as the unemployment rate hits 4.6%.
In September, most officials forecast economic growth of 1.2 percent in 2023, followed by a 1.7 percent increase in 2024, with the unemployment rate reaching 4.4 percent.
The meeting in December marks an important moment for the Fed, which this year has embarked on its most aggressive attempt to tighten monetary policy since the early 1980s. As the central bank’s actions began to have a noticeable impact on the economy, a debate has emerged over how much more restraint is needed to contain inflationary pressures that remain high in many sectors.
Powell earlier said “significantly more evidence” than one month’s worth of data would be needed to be convinced that inflation was indeed easing, noting past periods when better-than-expected data were followed by further increases.
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U.S. home prices fell from their recent peak as mortgage rates rose, the manufacturing sector weakened and consumer sentiment remained subdued.
However, the labor market continues to show resilience. The unemployment rate is still hovering at a historic low of 3.7 percent and wages have risen sharply amid an acute labor shortage, accelerating to a pace officials warn risks triggering even more price pressures .
Powell recently said it was “very plausible” that the Fed could reduce inflation without triggering a recession. However, a new study conducted by the Financial Times casts doubt on this result. Of the economists surveyed, 85 percent expect a recession next year.
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