Federal Reserve officials earlier this month agreed that smaller rate hikes should happen soon after assessing the impact policy is having on the economy, according to minutes of the meeting released Wednesday.
Echoing statements made by multiple officials over the past few weeks, the summary of the meeting indicated that smaller rate hikes are on the way. Markets widely expect the rate-setter Federal Open Market Committee to retreat to a 0.5 percentage point hike in December, after four consecutive 0.75 percentage point hikes.
Despite hinting that less severe moves are ahead, officials said they still see little sign of inflation easing. However, some committee members expressed concern about the risks to the financial system if the Fed continues to push at the same aggressive pace.
“A substantial majority of participants felt that slowing the rate of increase would probably soon be appropriate,” the minutes said. “Uncertain lags and magnitudes associated with the effects of monetary policy actions on economic activity and inflation were among the reasons cited why such an assessment was important.”
The minutes noted that smaller increases would allow policymakers to assess the impact of a succession of rate hikes. The next decision of the central bank on interest rates is on December 14.
The summary noted that several members indicated that “slowing the rate of increase could reduce the risk of instability in the financial system.” Others said they would like to wait to slow down. Officials said they see the balance of risks to the economy now skewed to the downside.
Focus on terminal speed, not just pace
Markets were looking for clues not only about what the next rate hike might look like, but also about how far policymakers think they will have to go next year to make satisfactory progress against inflation.
Officials at the meeting said it was just as important for the public to focus more on how far the Fed will go with interest rates, rather than the pace of further increases in the target range.
The minutes noted that the final rate was likely higher than officials had previously thought. At the September meeting, committee members had penciled in an interest rate for final funds of around 4.6%; recent statements indicate that the level may exceed 5%.
Over the past few weeks, officials have spoken largely in unison about the need to continue to fight inflation, while also indicating that they may withdraw the level of interest rate hikes. This means a strong likelihood of a 0.5 percentage point increase in December, but still an uncertain rate after that.
Markets expect several more rate hikes in 2023, with the funds rate reaching around 5%, and then possibly some cuts before the end of next year.
The statement after the FOMC meeting added a sentence that markets interpreted as a signal that the Fed would make smaller increases in the future. That sentence reads: “In determining the pace of future increases in the target range, the Committee will 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.”
Investors saw that as a hint of the reduced intensity of hikes after four straight 0.75 percentage point increases that pushed the Fed’s benchmark overnight lending rate to a range of 3.75%-4%, the highest level in 14 years.
When will the hikes end?
Several Fed officials have said in recent days that they expect a likely half-point move in December.
“They get to a point where they don’t have to move as fast. That’s helpful because they don’t know exactly how much tightening they’re going to have to do,” said Bill English, a former Fed official now with the Yale School of Management. “They emphasize that politics works with delays, so it’s useful to be able to go a little slower.”
Inflation data has recently shown some encouraging signs, while remaining well above the central bank’s official target of 2%.
The consumer price index rose 7.7% in October from a year earlier, the lowest level since January. However, a measure the Fed follows more closely, the personal consumer price index excluding food and energy, showed a 5.1% annual increase in September, up 0.2 percentage points from August and the highest reading since March.
These reports came out after the Fed’s November meeting. Several officials said they were positive about the reports but would need to see more before considering easing the policy.
The Fed has come under some criticism recently that it may be tightening too much. The worry is that policymakers are too focused on retrospective data and missing signs that inflation is easing and growth is slowing.
However, English expects Fed officials to keep their collective foot on the brake until there are clearer signals that prices are falling. He added that the Fed is willing to risk slowing the economy as it pursues its goal.
“They have risks both ways if they do too little and they do too much. They’ve been pretty clear that they see the risks of inflation coming out of the box and the need for really big tightening as the biggest risk,” he said. “It’s a tough time to be [Fed Chairman Jerome] Powell.”