Seeing economic slowdown, Fed pulls back with 0.25% rate hike

With inflation cooling, Fed Chair Jerome Powell sees "a path" to bringing down inflation without a spike in unemployment.

Chicago Federal Reserve Bank Building

The Federal Reserve raised its benchmark interest rate by 0.25% on Wednesday. The move at once continued the central bank’s campaign to fight inflation by using its monetary policy tools, and at the same time marked a slowdown in rate hikes.

The 0.25% increase was below the 0.5% increase made in December, and well below the series of 0.75% hikes delivered throughout the latter half of 2022.

“Shifting to a slower pace will better allow the committee to assess the economy’s progress toward our goals as we determine the extent of future increases that will be required to attain a sufficiently restrictive stance,” Fed Chair Jerome Powell said.

For the consumer economy, rising interest rates carry with them the specter of a slowdown in demand. The casualty of falling prices is tougher decisions on spending for households. But in the long run, falling inflation will mean consumers are more willing to spend on discretionary purchases as they spend less on gas and food. The question is how long and deep the short-term period of pain will stretch.

For takeaways on what's next, here’s a look at what Powell said about the state of the economy, inflation, the Fed’s plans and more:

The economy: Signs of a slowdown, but job growth remains

After retailers reported consumer pullback and challenges to profitability in the recently-completed holiday season, there’s keen interest in how the Fed’s actions are affecting the economy. Powell indicated that the Fed’s actions are beginning to have an impact. He offered the following assessment:

The U.S. economy slowed significantly last year, with real GDP rising at a below-trend pace of 1 percent. Recent indicators point to modest growth of spending and production this quarter. Consumer spending appears to be expanding at a subdued pace, in part reflecting tighter financial conditions over the past year. Activity in the housing sector continues to weaken, largely reflecting higher mortgage rates. Higher interest rates and slower output growth also appear to be weighing on business fixed investment.

Despite the slowdown in growth, the labor market remains extremely tight, with the unemployment rate at a 50-year low, job vacancies still very high, and wage growth elevated…Although the pace of job gains has slowed over the course of the past year, and nominal wage growth has shown some signs of easing, the labor market continues to be out of balance.

As for this year, Powell said his assessment is that growth will continue in the economy in 2023, but at a “subdued level.”

Soft landing: Still possible

Can the Fed bring down inflation without seeing a significant economic slowdown that leads unemployment to rise?

That’s the question facing the central bank's key committee, and it is one that the central bank continues to wrestle with as it hikes rates. The labor market has continued to show strength even with the aggressive tightening over the last year, and that’s a key indicator of demand for goods. Powell still sees a possibility that there won’t be a significant recession.

“I think most forecasters would say that unemployment will probably rise a bit from here, but I still think…that there’s a path to getting inflation back down to 2% without a really significant economic decline or a significant increase in unemployment,” Powell said. “And that’s because…the setting we’re in is quite different.”

By different, he means that the pandemic-era supply and demand imbalance that was a major driver of inflation is unprecedented. In turn, there is little to repair the fallout from that rebalancing, as well.

Inflation: A start to price relief

The Fed sees signs of the disinflationary process starting, Powell said. In particular, goods inflation is coming down as supply chains move back into balance. But Powell said that the process of 40-year-high prices coming down is at an “early stage,” especially as inflation in services and housing continues to be elevated.

“The inflation data received over the past three months show a welcome reduction in the monthly pace of increases,” he said. “And while recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path.”

Rate increases: How high and how long?

Now that the Fed has slowed down, a key question is how much higher the interest rates will go, and when it will stop hiking rates altogether.

There was little hard evidence offered Wednesday. The Fed’s statement left existing language in place that it believed further increases were necessary. Powell fielded a variety of questions on the duration and size, but didn’t commit to any specific plan.

He reiterated what he has throughout this period: “The historical record cautions strongly against prematurely loosening policy. We will stay the course until the job is done.”

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