Federal Reserve officials left interest rates unchanged in their final 2023 monetary policy decision and predicted they will cut borrowing costs three times in the coming year, a sign that the central bank is moving into the next phase in its fight against rapid inflation .
Interest rates have been at 5.25 to 5.5 percent since July. After a rapid series of increases that began in March 2022 and pushed borrowing costs to their highest in 22 years starting this summer, officials stuck with the policy for three straight meetings.
This patient stance has given policymakers time to assess whether interest rates are high enough to weigh on the economy and ensure that inflation will slow to the Fed's 2 percent target – and increasing – over time Slowing inflation and a cooling labor market have convinced them that this policy is in a good place. Jerome H. Powell, the Fed chairman, said during his news conference on Wednesday that officials no longer expect to raise interest rates again.
In fact, Fed policymakers predicted Wednesday that they would cut borrowing costs to 4.6 percent by the end of 2024, significantly less than their previous estimate of 5.1 percent released in September. The forecast assumes officials will make three quarter-point interest rate cuts next year.
Markets cheered as Fed policymakers painted an optimistic vision of a future with lower interest rates. The S&P 500 index surged after the Fed's policy decision and continued to climb as Powell spoke, key Treasury yields fell and investors increasingly bet that the Fed could cut interest rates as early as March.
Mr. Powell avoided declaring victory over inflation and refrained from commenting on when interest rate cuts might begin or what criteria would justify them. Still, he struck a sunny tone during his news conference, celebrating recent progress on inflation and expressing cautious hope that it could slow further without causing serious economic problems.
“Inflation has moderated from its peaks, and this has been done without a significant increase in unemployment – that is very good news,” Powell said, but stressed that “the path forward is uncertain.”
Inflation has previously surprised officials by rising after a slowdown, and policymakers made clear Wednesday that they could still raise interest rates if prices unexpectedly rise.
“Participants did not record additional hikes,” Powell said. “The participants also did not want to take the possibility of further interest rate increases off the table.”
But despite that caveat, the overall message was that “they feel much better about the policy design and are charting a course for rate cuts next year,” said Matthew Luzzetti, chief U.S. economist at Deutsche Bank. He said he thinks the Fed could outline what would justify rate cuts as early as January.
Calls for lower rates were widespread, as evidenced by Wednesday's announcement: Not a single Fed official expected rates to be higher at the end of next year.
This change in outlook comes as the American economy makes long-awaited and significant progress toward slower price increases.
Americans have been grappling with soaring inflation since prices began rising rapidly in early 2021. Costs initially skyrocketed as global supply chains collapsed and there were shortages of products such as cars and furniture. Inflation was then exacerbated by a rise in fuel and food costs following Russia's invasion of Ukraine in 2022.
These major shocks met with strong demand: households had saved a lot of money during the pandemic, partly because they received aid payments from the government. Because companies were enthusiastic about spending, they had the wherewithal to raise prices without scaring away customers. Companies themselves began paying more as they sought to attract workers to a strong job market with far more job openings than there were applicants available.
This is where Fed policy came into play. The central bank quickly increased borrowing costs starting last year — even in a series of huge three-quarter-point hikes — to make it more expensive to borrow money to buy a home, finance a car purchase or accumulate credit card debt. The aim was to cool demand and weaken the booming job market.
In recent months, a combination of supply chain recovery and somewhat weaker demand has caused inflation to fall significantly. Data this week showed that overall consumer price growth slowed to 3.1 percent in November, down sharply from the peak of 9.1 percent in summer 2022.
The November edition of the Fed's preferred inflation measure, which is different but related and more delayed, is due out on December 22nd.
Fed officials were also encouraged to see the labor market cooling. The number of job vacancies has fallen significantly and employers are hiring heavily, but no longer at top speed. As labor supply and demand balance, wage growth slows.
Officials believe more modest wage increases could pave the way for slower price increases in services – non-physical purchases like haircuts and rent – that have replaced goods as the main driver of inflation.
Historically, efforts to reduce inflation by sharply slowing demand have ended in recession. But officials are increasingly confident that this time could be different.
The Fed's economic forecasts released Wednesday showed policymakers expect inflation to return to 2 percent by 2026. They also showed that officials still expect unemployment to rise slightly, reaching 4.1 percent next year, as growth slows but remains positive.
That would be a big win for the Fed, especially considering that many forecasters were still predicting a looming recession in late spring and early summer.
Mr. Powell reiterated that he had “always” seen a way to slow inflation without causing major economic problems, noting that the economy appears to be making progress toward what economists call a “soft landing” as the Labor market remains strong and inflation is cooling.
“Inflation continues to decline, the labor market continues to rebalance,” Powell said Wednesday. “It's been so good so far, although we expect it to get more difficult from here on out, but so far that's not the case.”
— Joe Rennison contributed reporting.