Fed Creeps Toward Next Phase in Its Fight Against Inflation

Federal Reserve officials are expected to leave interest rates unchanged at their meeting on Wednesday, buying themselves more time to assess whether borrowing costs are high enough to weigh down the economy and wrestle inflation under control.

But investors are likely to focus less on what policymakers do on Wednesday — and more on what they say about the future. Wall Street will closely watch whether Fed policymakers still expect to make another interest rate increase before the end of the year or whether they are edging closer to the next phase in their fight against rapid inflation.

Central bankers have already raised interest rates to a range of 5.25 to 5.5 percent, the highest level in 22 years. By making it more expensive to borrow to buy a house or expand a business, they are trying to slow demand across the economy, making it harder for companies to charge more without losing customers and slowing price increases.

Officials predicted in their last quarterly economic forecast — released in June — that they were likely to make one more rate increase before the end of 2023. They have kept that possibility alive throughout the summer even as inflation has begun to fade meaningfully. But key policymakers have sounded less intent on making another move in recent weeks.

The Fed’s chair, Jerome H. Powell, had suggested in June that further adjustment was “likely.” More recently, including during a closely watched speech in August, he said policymakers could nudge rates up “if appropriate.”

Jerome H. Powell, chair of the Federal Reserve, said in August that policymakers could nudge rates up “if appropriate.”Credit…T.J. Kirkpatrick for The New York Times

Fed officials will release economic projections after their gathering this week, which takes place on Tuesday and Wednesday, offering a fresh look at whether most policymakers still think one final rate increase is likely to be necessary. The projections will also show how officials are interpreting a confusing moment in the economy, when consumer spending has been stronger than many economists expected even as inflation has cooled down a bit more quickly.

Taken together, the revised forecasts, the Fed’s statement and a news conference with Mr. Powell after the meeting could give the clearest signal yet about how close the central bank thinks it is to the end of rate increases — and what the next phase of trying to fully wrangle inflation might look like.

“You’ve had many centrist Fed officials over the last few weeks say: We’re close to where we need to be — we may even be there,” said Michael Feroli, chief U.S. economist at J.P. Morgan.

Mr. Feroli thinks that there is a roughly two-thirds chance that policymakers will still forecast another rate move, and a one-third chance that they will predict that the current setting is likely to be the peak interest rate.

But even if the Fed signals that interest rates have reached their peak, officials have been clear that they are likely to stay elevated for some time. Policymakers think that simply keeping rates at a high level will continue to weigh on economic growth and gradually cool the economy.

Mr. Feroli does not expect officials to start talking too decisively about the next phase — one in which rates come down — quite yet.

“They haven’t won the war on inflation, so it’d be a little premature,” Mr. Feroli said.

That said, the economic forecasts could offer some hints. Fed officials will release their projections for interest rates in 2024, 2025 and — newly — 2026 after this meeting. In June, their 2024 projections had suggested that officials expected to lower borrowing costs four times next year. The questions is when in the year those cuts would come, and what officials would need to see to feel comfortable lowering rates.

Policymakers may offer little clarity on those points on Wednesday, hoping to avoid a big market reaction — one that would make their job of cooling the economy more difficult.

If stocks were to shoot up as markets broadly began to anticipate that the Fed-induced financial and economic squeeze was likely to come sooner, it could make it cheaper and easier for companies and households to borrow money. That could speed up the economy when the Fed is trying to slow it down.

Already, growth has been surprisingly resilient to the Fed’s high rates. Consumers and companies have continued to spend at a healthy clip despite the many economic risks on the outlook — including the resumption of federal student loan repayments in early October and a possible government shutdown after the end of this month.

Consumer spending has been stronger than many economists had expected even as inflation has cooled down a bit more quickly.Credit…Karsten Moran for The New York Times

Leftover household savings from the pandemic, a strong labor market with solid wage growth, and various government policies meant to spur infrastructure and green energy investment may be helping to feed that momentum.

The resilience could prompt another revision to the Fed’s economic forecasts on Wednesday, economists at Goldman Sachs said: Officials might mark up their estimate of the so-called neutral rate, which signals how high interest rates need to be in order to weigh on the economy. That would suggest that while policy was restraining the economy today, it wasn’t doing so quite as intensely as officials would have expected.

The economy’s staying power could also prevent policymakers from sounding too excited about the recent slowdown in inflation.

Consumer Price Index increases have cooled notably over the past year — to 3.7 percent in August, down from 9.1 percent at their 2022 peak — as pandemic disruptions fade and prices of goods that were in short supply fall or grow more slowly.

The Fed’s preferred inflation indicator, which is released at more of a delay than the Consumer Price Index measure, is expected to have climbed slowly on a monthly basis in August after food and fuel prices are stripped out to give a clearer sense of the inflation trend.

The moderation is unquestionably good news — it makes it more likely that the Fed could slow the economy just enough to cool price increases without tanking the economy. But policymakers may worry about fully stamping out inflation in an economy that is still growing robustly, said William English, a former Fed economist who is now a professor in the practice of finance at Yale.

If consumers are still willing to spend, companies may find that they can still raise prices to pad or protect profits. Given that, officials may think that a more marked economic slowdown will be needed to bring inflation the whole way down to their 2 percent goal.

“The economy stayed stronger for longer than they’d been thinking,” Mr. English said. Given that, Fed officials may maintain that their next move is more likely to be a rate increase than a rate decrease.

Mr. English is skeptical that Fed officials think they can cool price increases fully without more of an economic slowdown.

“I doubt they are expecting, as their most likely forecast, that they’re going to get an immaculate disinflation,” he said. “I think that is still their base case: The economy really does have to have a period of quite slow growth.”

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