The Federal Reserve’s policy-setting committee on Wednesday voted to leave its policy rate unchanged, suggesting that the economy is moving in the right direction and inflation impulses are easing. The decision leaves the overnight lending target rate for banks at between 5.25% and 5.5%, which the Fed believes is restrictive territory or a level that constrains economic growth.
The last time the committee raised rates was at its July meeting.
Recent data has shown the economy to be more resilient than expected in the face of the 500 basis points added so far in the Fed’s tightening cycle over the past two years as it sought to bring stubborn inflation closer to its 2% target, even as the labor market continued its strong streak of job gains. Those gains have begun to slow, adding to optimism that the Fed may be able to usher the economy to a soft landing, where inflation can be brought down without a significant rise in the unemployment rate.
The market had been largely expecting this outcome, as it was broadly transmitted by Federal Reserve governors in recent weeks. But the latest inflation report released last week revealed an acceleration to 3.7% in September over the year, surprising most analysts who had expected the measure to have peaked in prior months. Much of the increase was attributed to higher energy prices as production cuts cut into supply.
In his comments at the Fed’s policy retreat in Jackson Hole, Wyoming, in late August, Fed Chair Jerome Powell asserted that the central bank would not tolerate sustained elevated inflation and is willing to see economic activity stall in order to contain price increases. The Fed’s move today appears aimed at quelling fears that inflation is becoming entrenched.
In today's post-meeting press conference, Powell noted that a “soft landing is a primary objective” of the committee’s actions.
In a separate note, the Fed released its updated Summary of Economic Projections or the forecasts of economic activity prepared by individual committee members. Compared to projections released in June, the median view of economic growth for 2023 doubled from 1.0% to 2.1%, a significant acceleration supported by robust consumer spending, and projections for growth in 2024 were raised from 1.1% to 1.5%.
Inflation as measured by the core personal consumption expenditures price index is expected to be 3.8% in 2023, a continued acceleration over the June forecast of 3.2% from the last statement, falling to 2.5% in 2024 and 2.2% in 2025. The median view of the unemployment rate in 2023 was revised lower to 3.8% from 4.1%, rising to 4.1% in 2024 as the economy slows.
Committee members expect the federal funds rate to reach 5.6% by the end of 2023, suggesting another 25 basis points to be added to the policy rate by the end of the year. The committee has two more meetings planned in 2023. Their current projections indicate rates would end 2024 at 5.1% before falling to 3.9% in 2025.
Market watchers are expecting rate cuts to begin in the second quarter of 2024 under the expectation that economic growth will slow and inflation ease to meet the Fed’s target. However, the path of those cuts is expected to be slow, with 2024 ending with less than 75 basis points shaved off the target rate, and 2025 seeing a continued cautious approach.
While the economy has gained momentum in the third quarter, and forecasters are expecting economic growth to pick up, recession expectations are still on the table. Oxford Economics sees the economy falling into recession in the fourth quarter, albeit a very mild one. The additional burden of tightening financial conditions is the main motivator of the downdraft.