WASHINGTON—The Federal Reserve held interest rates steady and signaled inflation had improved more rapidly than anticipated, opening the door to rate cuts next year.
Most officials penciled in three interest rate cuts for 2024 in projections released after their two-day meeting on Wednesday.
Officials have been hesitant to declare mission accomplished and were careful not to rule out higher rates in their policy statement, which was little changed from recent versions that have said tighter policy remains possible.
But another hike seems remote because inflation has been moving down much faster than officials anticipated this year. In their latest projections, officials expected core prices, which exclude volatile food and energy items, to rise 3.2% this quarter from a year ago, down from a projection of 3.7% in September. They see core inflation of 2.4% at the end of next year, down from 2.6% in September.
With Wednesday’s decision, the Fed has now held its benchmark federal-funds rate steady at three consecutive policy meetings. They began raising rates from near zero in March 2022 and lifted them most recently in July to a range between 5.25% and 5.5%, a 22-year high.
Most Fed officials have been reluctant to publicly discuss when they might begin cutting rates, but investors in interest-rate futures markets expect them to start next spring and to lower the fed-funds rate by at least 1 percentage point by the end of 2024.
In September, officials had projected one more increase this year followed by two cuts next year, taking the fed-funds rate to around 5.1%. On Wednesday, officials projected they would lower rates to around 4.6% by the end of 2024, the equivalent of three quarter-point reductions.
Central-bank officials are trying to balance two risks: One is that they move too slowly to ease policy and the economy finally crumples under the weight of higher interest rates, causing millions of people to lose their jobs.
The other is that they ease prematurely and inflation settles above 3%—higher than their 2% goal.
The U.S. economic outlook has brightened in recent months because inflation and wage growth are slowing. That would give the Fed more room to lower rates rapidly if the economy weakens more than officials expect, and it could open the door to cuts even if the expansion doesn’t stall.
Government data released Wednesday suggest core prices, which exclude food and energy items, will show a very mild gain for November as measured by the Fed’s preferred inflation gauge when it is released later this month. That could put the six-month annualized inflation rate at or slightly below the Fed’s 2% target.
Meanwhile, the labor market has been cooling but remains solid. The unemployment rate ticked down to 3.7% last month from 3.9% in October, and private-sector employers have added an average of 130,000 jobs a month over the past six months, down from 228,000 during the six months before that.
One year ago, many economists anticipated that Fed officials would have to raise rates to levels that would create enough slack—such as unemployed workers and idled factories—to significantly slow inflation. But healed supply chains and an influx of workers into the labor force are curbing wage and price increases without causing broad economic weakness.
The reasons why officials lower rates matter. Often, the central bank trims rates to shore up a deteriorating economy and job market. Indeed, this forms the basis for several analysts’ forecasts of cuts next year.
But Fed officials have acknowledged that they could lower rates next year simply because inflation is well on its way to their 2% target. Holding rates steady as inflation falls would lead inflation-adjusted or “real” rates to rise, which the Fed doesn’t want. Officials could lower nominal rates simply to prevent real interest rates from turning too tight.
Fed governor Christopher Waller fueled optimism about this possibility last month when he said the central bank could theoretically begin reducing rates by the spring if inflation behaves especially well.
“If we see this [lower] inflation continuing for several more months—I don’t know how long that might be, three months, four months, five months?—we might feel confident that inflation is really down,” said Waller.
Still, officials don’t want to declare victory yet on inflation or cause a market rally that makes it harder to sustain the slower economic growth they believe necessary to conquer inflation.
This article was originally published in The Wall Street Journal on December 13, 2023, and written by Nick Timiraos. PHOTO/iStock image
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