Fed on track for smaller rate hikes after cool US inflation data

Investors seized on the numbers as a sign that the Fed would dial down the pace of its tightening campaign. PHOTO: REUTERS

NEW YORK – The Federal Reserve is on track to downshift to smaller interest rate increases following a further cooling in United States inflation, though it is likely to keep hiking until price pressures show more definitive signs of slowing.

Philadelphia Fed president Patrick Harker, speaking on Thursday morning shortly after the Labour Department’s release of consumer price data, said rate hikes of a quarter-percentage point “will be appropriate going forward”, following bigger increases throughout most of 2022. Dr Harker’s comments echoed remarks a day earlier from Dr Susan Collins, his counterpart at the Boston Fed.

Consumer prices rose 6.5 per cent in the 12 months to December, marking the slowest inflation rate in more than a year. So-called core inflation, which excludes food and energy, was up 5.7 per cent over the same period, the smallest advance in a year. Both figures matched median forecasts.

Investors seized on the numbers as a sign that the Fed would dial down the pace of its tightening campaign, which ramped into high gear last year amid the fastest inflation in four decades. The Dow Jones Industrial Average closed up 0.64 per cent after the report.

The message of moderation was later reinforced by Richmond Fed president Thomas Barkin, who told a bankers’ conference that “it makes sense to steer more deliberately as we work to bring inflation down”. On the other hand, his St Louis colleague James Bullard separately said that he continued to favour front-loading policy moves to get rates above 5 per cent “as soon as possible”.

Dr Harker is the only voter this year on monetary policy among the four officials who spoke publicly on Thursday.

With the central bank’s benchmark rate now at 4.3 per cent, market participants expect a quarter-point rate hike at the Jan 31-Feb 1 meeting. Traders have also started to price in a small possibility that the Fed will forgo a rate hike in March. Swaps shifted to show fewer than 50 basis points of tightening priced in across the next two meetings.

While moderating inflation paves the way for a slower pace of rate increases in 2023, the market’s expectation of rate cuts later in the year is still at odds with Fed guidance. Policymakers have emphasised the need to hold rates at an elevated level for quite some time and cautioned against underestimating their will to do so.

The outlook for interest rates probably hinges on developments in services prices in particular, a category that Fed chair Jerome Powell and his colleagues have homed in on in recent months. Officials have voiced concern that elevated wage growth will feed into prices in the services sector, keeping inflation there elevated until the labour market softens.

So far, there are few signs of such weakness. A separate Labour Department report on Thursday showed that applications for unemployment benefits remained at a historically low level last week. The latest monthly jobs report showed some cooling in wage growth in December, but hiring was still robust and the unemployment rate fell to match a five-decade low.

While it is broadly expected for annual price growth to substantially slow this year, a lot of uncertainty remains as to how far inflation may fall and whether the Fed’s rapid rate increases ultimately tip the US into recession.

Some Fed watchers cautioned that the coast is not clear for a downshift to quarter-point hikes, despite the good news on inflation.

“The base case for the February meeting is 25 basis points, but with still notable risk of 50 basis points,” said Piper Sandler head of global policy research Roberto Perli. “What matters the most is the peak rate, and there is no reason to believe that the Fed changed its mind about it being north of 5 per cent based on today’s report.”
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