In a move that surprised some observers, the United States Federal Reserve decided to keep interest rates unchanged on Wednesday, but adopted a more hawkish stance. The central bank projected another rate increase by the end of the year and indicated that monetary policy would remain significantly tighter through 2024 than previously anticipated. While Fed policymakers still expect the benchmark overnight interest rate to peak this year in the 5.5 percent to 5.75 percent range, just slightly above the current range, they now anticipate only a half-percentage-point decrease in rates in 2024, compared to the full percentage point of cuts predicted in June. The Fed's main measure of inflation is projected to drop to 3.3 percent by the end of this year, 2.5 percent next year, and 2.2 percent by the end of 2025. The central bank expects to reach its 2 percent inflation target by 2026.
The new projections also include an upward revision of economic growth estimates, with the Fed now expecting the economy to grow 2.1 percent in 2023. The unemployment rate is forecasted to remain steady at around 3.8 percent this year and rise to 4.1 percent by the end of the year. This indicates the Fed's confidence in containing inflation without causing significant job losses.
The Fed's decision to keep rates unchanged was widely expected by financial markets, but the more hawkish tone of the updated projections caught some investors off-guard. Bond yields rose and stocks initially weakened following the announcement, while the dollar erased its losses for the day against major currencies.
Market participants had been anticipating significant rate cuts by the Fed next year, but the projections revealed that 10 of the 19 officials see the policy rate remaining above 5 percent through 2023. This suggests that companies and households may face even tighter credit conditions and higher borrowing costs than they have already experienced during the Fed's aggressive efforts to contain inflation.
Economists interpreted the Fed's forecasts as a sign that officials are more confident in their ability to quash inflation without causing broader economic pain. The Fed's upward revision to growth forecasts and downward revision to the unemployment rate in 2024 indicate a central bank that is expecting a soft landing, despite maintaining higher interest rates for longer.
The Fed's decision to leave rates unchanged for the second time in three meetings reflects its effort to moderate its fight against inflation as price pressures have eased. However, Fed officials made it clear that they are not close to declaring victory over the current bout of inflation. The Fed's benchmark rate remains at about 5.4 percent, the result of 11 rate hikes since March 2022. The central bank aims to guide the economy toward a soft landing, cooling inflation without triggering a recession.
While consumer inflation has dropped from a year-over-year peak of 9.1 percent in June 2022 to 3.7 percent, it still exceeds the Fed's 2 percent target. The Fed's decision to keep rates high for an extended period suggests their concern that inflation might not be falling fast enough.
The Fed's updated economic projections indicate faster economic growth than previously expected, with estimates for this year and next year revised upward. Core inflation, excluding volatile food and energy prices, is now expected to fall to 3.7 percent by the end of the year, better than the 3.9 percent forecast in June. However, the costs of certain services, such as auto insurance and veterinary services, continue to rise faster than before the pandemic.
Despite progress in containing inflation, rising gas prices and ongoing economic expansion could keep inflation and interest rates high enough for an extended period, potentially weakening household and corporate spending and the overall economy.
The Fed's decision to keep rates unchanged was approved unanimously after a two-day meeting, which also marked new Fed Governor Adriana Kugler's debut on the central bank policymaking stage.
