The Federal Reserve kept interest rates unchanged on Wednesday (June 14) but signaled in new economic projections that borrowing costs will likely rise by another half of a percentage point by the end of this year as the US central bank reacted to a stronger-than-expected economy and a slower decline in inflation.
In an effort to balance risks to the economy with a still unresolved fight to control inflation, “holding the target (interest rate) range steady at this meeting allows the committee to assess additional information and its implications for monetary policy,” the rate-setting Federal Open Market Committee (FOMC) said in a unanimous policy statement issued at the end of its latest two-day meeting.
Further rate increases would “take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments,” it said.
The new projections, adding a hawkish tilt to Wednesday’s interest rate decision, show policymakers at the median see the benchmark overnight interest rate rising from the current 5.00 per cent-5.25 per cent range to a 5.50 per cent-5.75 per cent range by the end of the year. Half of the 18 Fed officials penciled in their “dot” at that level, with three seeing the policy rate moving even higher – including one official who sees it rising above six per cent.
Two Fed officials see rates staying where they are, and four see a single additional quarter-percentage-point increase as likely appropriate.
Policymakers, however, anticipate 100 basis points of rate cuts in 2024, alongside fast-falling inflation.
Combined, the rate outlook and the projections are likely to lead investors to expect a resumption of quarter-percentage-point rate increases beginning at the next policy meeting in July.
US stocks fell after the decision and traders of futures contracts tied to the policy rate newly reflect about a 75 per cent chance of another rate hike next month, with the probability of a rate cut by the end of the year dropping.
“It does seem as if the FOMC members have become even more hawkish since the last meeting, and I think that has taken investors by surprise,” said Sam Stovall, chief investment strategist at SFRA Research.
Stronger economic outlook
The higher rate outlook coincides with an improved view of the economy and, consequently, slower progress in returning inflation to the central bank’s two per cent target.
Fed officials at the median more than doubled their outlook for 2023 economic growth to one per cen t, from 0.4 per cent in the March projections, and now see the unemployment rate rising only to 4.1 per cent by the end of the year compared to 4.5 per cent in the March outlook.
The jobless rate as of May was 3.7 per cent.
The stronger-than-expected economy means inflation will fall more slowly, with the core Personal Consumption Expenditures Price Index dropping from the current 4.7 per cent to 3.9 per cent by the end of 2023, compared to a 3.6 per cent year-end rate seen in the March policymaker projections.
The decision snapped a string of 10 consecutive rate hikes delivered as the Fed responded to the worst outbreak of inflation in 40 years with a matching set of aggressive policy moves, including four outsized increases of three-quarters of a percentage point last year.
The central bank’s policy rate, which influences household and business borrowing costs throughout the economy, rose a full five percentage points from the onset of the tightening cycle in March 2022, reaching the highest level since just before the start of the 2007-2009 recession.