Smaller Fed rate hike may augur end to ‘ongoing’ increases

WASHINGTON  – The Federal Reserve is set to again slow the pace of its interest rate increases at a Jan. 31-Feb. 1 policy meeting while also signaling that its battle against inflation is far from over.

Economic data since the U.S. central bank’s last meeting in December have shown inflation continuing to wane, with consumer and producer prices, profits, and wages all growing more slowly, and major inflation drivers like rent hardwired to move down.

Policymakers have reacted, with many of them saying they are ready to raise rates by only a quarter of a percentage point at the upcoming meeting, a back-to-normal approach after a year in which the target policy rate was ratcheted up by 4.25 percentage points, with the bulk coming in 75-basis-point increments.

It was the fastest tightening of monetary policy since the 1980s. The Fed scaled back the pace in December to a half-percentage-point increase as a way to acknowledge that the main force of its credit tightening was yet to be felt in job markets and among consumers, and to more cautiously feel the way to an eventual stopping point.

Fed Vice Chair Lael Brainard said on Thursday that “logic” still applied as the central bank “probed” how much further to raise rates in an environment where inflation appears set to slow and the economy may be weakening.

After last year’s rapid rate increases, “now we’re in an environment where we’re balancing risks on both sides,” Brainard said on Thursday during an event at the University of Chicago’s Booth School of Business, even as she avoided, as the Fed’s second-ranking official, voicing an explicit policy preference for the upcoming meeting.

But Brainard also reiterated a view that the policy-setting Federal Open Market Committee’s next statement and Fed Chair Jerome Powell in his Feb. 1 news conference are likely to hammer home: Slowing inflation isn’t low inflation, and a smaller rate increase doesn’t mean the central bank is ready to pause yet.

The personal consumption expenditures price index, the Fed’s preferred measure of inflation, increased at a 5.5-percent annual rate in November, down from the June high of 7 percent but still far above the central bank’s 2 percent target. Consumer prices rose at an even faster 6.5 percent pace in December.

“Inflation is high, and it will take time and resolve to get it back down to 2 percent. We are determined to stay the course,” Brainard said.

New language?

The message of an unremitting battle against inflation has become a consensus mantra among the Fed’s 19 policymakers, but one they may be challenged to sustain if evidence continues to mount that the economy is slowing.

Throughout last year, the Fed’s rapid series of rate hikes were announced in a statement that also promised “ongoing increases” until rates were “sufficiently restrictive to return inflation to 2 percent.”

That language may be ripe for change, possibly as soon as the upcoming meeting. If the Fed follows through with the expected quarter-percentage-point increase on Feb. 1, the federal funds rate would be set in a range of between 4.5 percent and 4.75 percent, close to the level of just above 5 percent that Fed officials at the December meeting estimated as the likely stopping point.

Officials will not issue new projections at the upcoming meeting, so any shift in emphasis would need to come through the policy statement, which will be released at 2 p.m. EST (1900 GMT) on Feb. 1. Powell will start speaking half an hour later.

“Given they are getting kind of close to where they are wanting to pause, they should indicate that,” possibly with language pointing just to “further” increases rather than the more open-ended guidance for “ongoing” rate hikes, said Bill English, a former head of the Fed’s monetary affairs division who is now a professor at the Yale School of Management.

Any new language, however, would try to avoid the appearance of a promise around any particular stopping point.

‘The easy part’

Investors already see the Fed pausing with the target rate at a slightly lower level than policymakers project and then cutting rates later this year – a view that officials don’t want to encourage on the grounds it could serve to loosen the credit and financial conditions the Fed is trying to restrict.

Fed officials were surprised in 2021 by the persistence of inflation that at one point was more than triple their 2 percent target. They spent last year trying to catch up by raising interest rates, and now seem biased in favor of doing too much to restrain the pace of prices rather than doing too little out of fear of damaging the jobs market and economic growth.

“The history of inflation forecast errors in 2021/22 makes the Fed’s reaction function more conservative and less likely to take wins on the inflation front at face value,” said Edward Al-Hussainy, a rates analyst at Columbia Threadneedle, who termed the current phase of the Fed’s tightening cycle as “the easy part.”

The economy does appear to be slowing in ways the Fed hopes will ease the pressure on prices, with ebbing demand moving more in line with the supply of goods and services that the economy can produce or import.

U.S. retail sales in December were a disappointment. Industrial production, a broad measure of factory output for which peaks and declines are seen as possible evidence of a coming recession, passed its pre-pandemic high point last year but then fell sharply in November and December.

The evidence of slowing growth hasn’t, however, translated into a sharp slowdown in the job market or hiring – a fact that has made Fed officials focus on wage growth and remain reluctant to trust that the decline in inflation will continue. The unemployment rate is currently 3.5 percent, a level seen only rarely since World War Two.

A wage tracker compiled by the Atlanta Fed shows the three-month moving average of median wages still growing more than 6 percent as of December, lower than the average rate of consumer inflation but a pace many Fed officials feel is “inconsistent” with their inflation target.

The risk of going too far and putting too much pressure on the economy may be rising, Boston Fed President Susan Collins, one of the advocates for going more slowly, said on Thursday.

But that doesn’t mean it is time to stop.

“Restoring price stability remains our imperative,” Collins said during a conference at her regional bank. “Thus, I anticipate the need for further rate increases.”