Fed raises rates by a half point as central banks enter new phase

The Federal Reserve raised its benchmark rate by half a percentage point on Wednesday and signaled its intention to continue to squeeze the US economy into 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% to 4.5%, ending a streak of months rate hikes of 0.75 percentage points.

The pivot to lower rate hikes should be watched internationally, with the European Central Bank and the Bank of England both set to raise borrowing costs by half a percentage point Thursday.

Economists say inflation peaked in all three regions, with reductions in the overall rate in the United States and the UK this week, but central banks fear it will take too long to fall towards their 2% targets.

At a press conference after the decision, fed Chairman Jay Powell said: “We have come a long way and the full effects of our rapid tightening so far have yet to be felt. We still have work to do.

Powell welcomed the reduction in overall price growth in October and November, but warned “much more evidence will be needed to provide confidence that inflation is on a sustained downward path.”

In its statement, the Fed said “continued increases” in the key rate would be “appropriate” to ensure it dampens the economy enough to rein in price growth.

The exchanges were heated after Powell’s statement and press conference. The S&P 500 closed down 0.6% and the Nasdaq Composite lost 0.8%. The two-year Treasury yield, which moves with interest rate expectations, was flat at 4.2%.

Jay Barry, co-head of U.S. rates strategy at JPMorgan, said that before the decision, investors had debated whether the Fed would abandon the language of “continuous increases” in favor of something more dovish.

Sticking to the phraseology “suggests we’re several meetings away from the ongoing tightening cycle,” Barry added.

Along with the rate decision, the Fed released a revised “dot chart” of officials’ individual interest rate projections, which indicated support for further tightening next year.

The median estimate for the federal funds rate at the end of 2023 has risen to 5.1%, from the peak of 4.6% forecast in the last projection. published in september. This suggests a total of 0.75 points of rate hikes ahead.

Most officials now see the policy rate falling to 4.1% in 2024 and 3.1% in 2025. That compares to 3.9% and 2.9%, respectively, three months ago.

However, Powell noted that Fed officials have consistently raised their peak interest rate forecasts and warned, “I can’t tell you for sure that we won’t be raising our estimate. . . Again.”

A large cohort of policymakers forecast the policy rate to top 5.25% next year, with only two saying it should peak below 5%.

Asked about the potential for lower rates next year, as expected by traders in federal funds futures, Powell said the Fed was not yet on the verge of easing.

“I wouldn’t see us considering rate cuts until the committee is satisfied that inflation is down to 2% on a sustained basis. This is the test,” he said, adding that the dot plot suggests no easing in 2023.

Policymakers have raised their forecasts for inflation next year, with the median estimate of the price index for basic personal consumption expenditures – their preferred gauge of inflation – rising to 3.5% from 3.1 % in September.

By 2024, most officials predict it will have fallen to just 2.5%, still above the central bank’s target. It should drop to 2.1% the following year.

Policymakers were more optimistic about the outlook. The economy is expected to grow by just 0.5% in 2023 before registering an expansion of 1.6% in 2024, with the unemployment rate peaking at 4.6%.

In September, most officials forecast economic growth of 1.2% for 2023, followed by an increase of 1.7% in 2024, with the unemployment rate reaching 4.4%.

The December meeting marks an important turning point for the Fed, which this year embarked on the most aggressive attempt to tighten monetary policy since the early 1980s.

As central bank actions began to have a noticeable impact on the economy, a debate emerged on the need for more restraint to control inflationary pressures which remain high in many sectors.

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