The Federal Reserve hiked interest rates by half a percentage point on Wednesday, signaling its intention to keep the US economy under pressure next year as central banks on both sides of the Atlantic enter a new phase in the fight against inflation.
At its last 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 month-long string of 0.75 percentage point rate hikes.
The swing to smaller rate hikes is likely to follow internationally, with the European Central Bank and Bank of England both poised to hike borrowing costs by half a percentage point on Thursday.
Economists say inflation has peaked in all three regions, with interest rates cut in the US and UK this week, but central banks remain concerned it will take too long to get back to their 2% goals fall behind.
In a press conference following the decision, Fed Chair Jay Powell said: “We have come a long way and the full impact of our rapid tightening has not yet been felt. We still have work to do.”
Powell welcomed the decline in headline price growth in October and November, but cautioned that “it will take a lot more evidence to inspire confidence that inflation is on a sustained downward path.”
In its statement, the Fed said “ongoing hikes” in interest rates were “appropriate” to ensure they slowed the economy enough to bring price growth under control.
Trade was choppy after Powell’s statement and press conference. The S&P 500 closed 0.6 percent lower and the Nasdaq Composite lost 0.8 percent. The two-year Treasury yield, which moves with interest rate expectations, was unchanged at 4.2 percent.
Jay Barry, co-head of US interest rate strategy at JPMorgan, said investors debated before deciding whether the Fed would drop the language of “ongoing hikes” in favor of more dovish policy.
To stay with the phraseology, “suggests we are several meetings away from completing the tightening cycle,” Barry added.
Alongside the rate decision, the Fed released a revised “dot plot” of officials’ individual rate forecasts, indicating support for further tightening next year.
The median estimate for the fed funds rate through the end of 2023 rose to 5.1 percent from the peak of 4.6 percent forecast when the forecasts were last released in September. That points to rate hikes totaling 0.75 points still to come.
Most officials now see the federal funds rate falling to 4.1 percent in 2024 and 3.1 percent in 2025, down from 3.9 percent and 2.9 percent, respectively, three months ago.
Powell, however, noted that Fed officials have consistently raised their forecasts for peak interest rates, warning: “I can’t tell you with confidence that we won’t be moving our estimate up. . . again.”
A large cohort of policymakers expected the federal funds rate to top 5.25 percent next year, with only two saying it should peak below 5 percent.
When asked about the potential for rate cuts next year, as traders in fed funds futures are expecting, Powell said the Fed is not at the point to think about easing.
“I wouldn’t see us contemplating rate cuts until the committee is confident that inflation will come down to 2% on a sustainable basis. That’s the test,” he said, adding that the scatter chart suggests no easing in 2023.
Policymakers raised their forecast for inflation next year, with the median estimate for the core personal spending price index — their preferred measure of inflation — rising to 3.5 percent, compared with 3.1 percent in September.
In 2024, most officials expect it will have fallen to just 2.5 percent, which is still above the central bank’s target. A decline to 2.1 percent is forecast for the following year.
Policymakers were more pessimistic about the outlook. The economy is projected to grow just 0.5 percent in 2023 before posting 1.6 percent growth in 2024 as the unemployment rate stands at 4.6 percent.
In September, most officials were forecasting 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 a major turning point for the Fed, which this year made its most aggressive attempt at monetary tightening since the early 1980s.
As the central bank’s actions have started to have a noticeable impact on the economy, a debate has erupted about how much more restraint is needed to tame inflationary pressures, which remain elevated in many sectors.