The Federal Reserve wants to widen the inflation fight with the seventh interest rate hike in 2022

WASHINGTON– After four consecutive three-quarter-point rate hikes, the Federal Reserve is due to announce a smaller half-point hike in interest rates on Wednesday, a first step to scale back its efforts to fight inflation.

At the same time, the Fed is likely to signal that it plans more rate hikes next year than previously forecast to try to weather the worst inflation spike in four decades. And most economists believe that Chairman Jerome Powell will stress that the Fed is likely to keep interest rates at their peak into next year, even after rate hikes have ended.

Wednesday’s Fed decision will follow a government report on Tuesday that offered hopeful signs that inflation is finally starting to ease from chronically high levels. Gasoline prices fell, the cost of used cars, furniture and toys fell, and the cost of services from hotels to airline tickets to rental cars fell.

The six rate hikes the Fed has already pushed through this year have lifted its short-term interest rate to a range of 3.75% to 4%, the highest level in 15 years. Overall, the rate hikes have resulted in much more expensive borrowing rates for consumers and businesses, ranging from mortgages to auto and business loans. Concerns have grown that the Fed, in a bid to curb inflation, is raising rates so much that it will trigger a recession next year.

With inflation still uncomfortably high — November inflation was 7.1% yoy — Powell and other Fed officials have stressed that they expect rates to remain at their peak for an extended period of time.

With inflationary pressures now easing, most economists believe the Fed will continue to slow rate hikes, raising interest rates by just a quarter point at its next meeting early next year.

“The data (Tuesday) kind of aligns with our idea that the Fed will continue to downgrade in February,” said Matthew Luzzetti, an economist at Deutsche Bank and a former research analyst at the Fed. “The downshift helps maximize their prospects for a soft landing,” in which the Fed’s rate hikes would slow growth and tame inflation but not plunge 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 indicators for 2023 and beyond. Most analysts have forecast to register a peak range of at least 4.75% to 5% or even 5% to 5.25% versus their September forecast of 4.5% to 4.75%.

Despite Powell’s recent harsh rhetoric – he said late last month that “we haven’t seen clear progress in slowing inflation” – he and other Fed officials have made it clear that they are ready to slow the pace of rate hikes. In doing so, they have time to assess the impact of the increases already imposed. These hikes have slumped home sales and are beginning to lower rents on new homes, a major cause of high inflation.

Fed officials have also said they want rates to hit “restrictive” levels that will slow growth and hiring and bring inflation to their 2% target for the year.

“We will only learn over time as to which interest rate is sufficiently restrictive by watching how the economy performs,” ​​said Lisa Cook, one of seven members of the Fed’s Board of Governors. “With the tightening already in the pipeline, I am aware that monetary policy works with long lags.”

Fed officials have emphasized that how quickly they raise rates is more important than how long they keep them at or near their peak. In September, the Fed predicted that would happen by 2023. But Wall Street investors are now betting that the Fed will reverse course and start cutting rates before the end of next year.

In comments late last month, Powell said he follows price trends in three different categories to best understand inflation’s likely path: goods, excluding volatile food and energy costs; housing, which includes renting and the cost of home ownership; and non-residential services, such as auto insurance, pet services, and education.

In his speech, Powell noted that there had been some progress in controlling inflation in goods and housing, but not in most services. Some of these trends extended into last month’s data, with non-food and energy commodity prices falling 0.5% from October to November, the second straight monthly decline.

Housing costs, which account for almost a third of the consumer price index, continue to rise. But real-time measurements of apartment rents and home prices are beginning to fall after showing rapid price acceleration at the height of the pandemic. Powell said those declines are likely to show up in government data next year and should help bring headline inflation down.

As a result, Powell’s biggest focus has been on services, which he thinks are likely to remain elevated. That’s partly because large wage increases are becoming a major driver of inflation. Service businesses such as hotels and restaurants are particularly labor intensive. And with average wages rising at 5-6% annually, price pressures in this sector of the economy continue to build.

How the Fed will rein in a resilient labor market to bring down inflation could prove dangerous. Powell and other Fed officials have said they hope their rate hikes will slow consumer spending and job growth. Companies would then cut many of their job offers and reduce the demand for labour. With less competition for workers, wages could rise more slowly.

Powell even gave a wage target: He believes annual wage growth of around 3.5% is consistent with 2% inflation. At the moment, the average wage is growing by about 5% to 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 are forecasting a potentially higher unemployment rate through the end of 2023. If so, it would indicate they are forecasting more layoffs and likely a recession.

Copyright © 2022 by The Associated Press. All rights reserved. The Federal Reserve wants to widen the inflation fight with the seventh interest rate hike in 2022

Laura Coffey

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