by Federal Reserve officials welcomed a recent slowdown in inflation at their last meeting in late January, but intended to proceed cautiously as they tiptoed toward rate cuts, according to minutes from that meeting. that were published on Wednesday.
Central bankers sharply raised interest rates from March 2022 to July 2023, taking them to 5.3 percent from a starting point near zero. Those measures were intended to cool consumer and business demand, which officials hoped would curb rapid inflation.
Now, inflation is slowing significantly. Consumer prices rose 3.1 percent in the year to January, well below their recent peak of 9.1 percent. But that’s still faster than the normal pace before the pandemic, and is above the central bank’s target: The Fed is aiming for 2 percent inflation over time using a different but related metric, the index. of personal consumption expenses.
The economy has continued to grow at a solid pace even as price growth has moderated. Hiring has continued to be stronger than expected, wage growth is advancing and retail sales data has suggested that consumers are still willing to spend.
That combination leaves Fed officials contemplating when (and how much) to cut interest rates. While central bankers have made clear they do not believe they need to raise borrowing costs further at a time when inflation is moderating, they have also suggested they are in no rush to cut rates.
“There has been significant progress recently in returning inflation to the committee’s long-term objective,” Fed officials reiterated in their newly released minutes. Officials thought lower rental prices, improving labor supply and productivity gains could help inflation moderate further this year. Officials also suggested that “upside risks to inflation” had “declined,” suggesting they are more confident that inflation is falling sustainably.
But they also identified risks that could drive up inflation. In particular, “participants noted that aggregate demand momentum may be stronger than currently assessed, especially in light of the surprising resilience of consumer spending last year.”
When policymakers last released their economic projections in December, their forecasts suggested they could make three quarter-point rate cuts this year, to about 4.6 percent. Investors are now betting that rates will end 2024 at around 4.4 percent, although there is a feeling they could end up slightly higher or lower.
When thinking about the future of policy, Fed policymakers must balance competing risks.
Leaving interest rates too high for too long would risk slowing growth more than officials want, a concern that “a couple” of officials raised at the Federal Reserve meeting in late January. Too strict a policy could increase unemployment and could even lead to a recession.
On the other hand, cutting rates prematurely could suggest to markets and ordinary Americans that the Federal Reserve is not serious about crushing inflation until it completely returns to normal. If price increases were to rise again, it could be even more difficult to curb them in the future.
“Most participants noted the risks of acting too quickly to soften the policy stance,” the minutes said.
Authorities are also contemplating when to stop reducing their balance of bond holdings so quickly.
Officials bought a lot of Treasury and mortgage-backed debt during the pandemic, first to calm troubled markets and then to stimulate the economy by making longer-term borrowing even cheaper. That increased the size of the Federal Reserve’s balance sheet. To reduce those holdings to a more normal level, officials have allowed the securities to mature without reinvesting the proceeds.
But central bankers want to tread carefully: If they adjust the balance sheet too quickly or too much, they risk disrupting the functioning of financial markets. In fact, that happened in 2019 after a similar process.
Officials decided at their meeting that “it would be appropriate” to begin in-depth discussions on the balance sheet at the next Federal Reserve meeting, which will take place in March, and some suggested that slowing the pace of the contraction might be helpful. and that doing so “could allow the committee to continue with the balance sheet settlement for longer.”
