Fed tightens grip on economy even as inflation cools

Inflation is finally starting to cool off, but Federal Reserve Chair Jerome Powell isn’t satisfied.

Despite two straight months of slowing price spikes, Fed officials raised interest rates yet again on Wednesday — and said they are now more pessimistic about what inflation might look like next year, according to widely anticipated projections that central bank policymakers released after a two-day meeting.

They hiked rates by another half a percentage point. And while that was a smaller boost than the supersized increases enacted in the previous four meetings, they expect to increase borrowing costs another percentage point in 2023, which would bring their main policy rate above 5 percent.

“We made less progress than expected on inflation,” Powell said at his post-meeting press conference. “I can’t tell you confidently that we won't move up our estimate of the peak [interest] rate again.”

The news comes even amid hopes that inflation, which has gripped the U.S. since the economy began to emerge from the pandemic, is beginning to subside. The government said this week that price growth slowed again in November, but the central bank is showing no sign of halting its almost year-long campaign to drive up borrowing costs to slow economic growth and spending — even if it tips the economy into a recession.

Members of the Fed’s rate-setting committee said they expect the so-called personal consumption expenditure index — the measure of inflation they watch most closely — to rise 5.6 percent this year, still nearly three times more than their 2 percent target. But they now expect to close out 2023 with PCE still a touch above 3 percent. That’s compared to last quarter, when they projected inflation would stand at 2.8 percent at the end of next year.

Although the central bank doesn't outright project a recession — policymakers see near-zero growth for this year and next — a downturn is strongly implied by the rest of their estimates. In particular, officials see the unemployment rate rising to 4.6 percent next year.

Powell has said he’s especially watching the upward pressure that the remarkably strong labor market is putting on wages, which he says could prevent inflation from falling back to 2 percent.

U.S. employees created a robust 263,000 jobs in November, beating analysts’ expectations again, while the unemployment rate stayed at a low 3.7 percent. That’s helping drive economic growth even in the face of the central bank's efforts to slow things down.

“We believe you need to see a better balancing of supply and demand in the labor market,” the Fed chief said.

“It’s not that we don’t want wage increases,” said Powell, who has come under fire from Sen. Elizabeth Warren and other progressives for punishing workers with the restrictive monetary policy. But inflation is feeding into wages, he said, making them rise at a rate “well above what is consistent with 2 percent inflation.”

Many investors are also hurting. Stocks fell after the meeting as the Fed signaled that more rate increases were to come next year. Powell warned markets that the Fed is still trying to keep stocks and bonds on their downward trajectory this year since a decline in securities leaves people with less money to spend, even as investors keep looking for openings to rally.

“Financial conditions fluctuate in the short term in response to many factors, but it is important that over time they reflect the policy restraint we are putting in place to return inflation to 2 percent,” he said.

Officials see inflation dropping to 2.5 percent by 2024, at which point the central bank will begin to loosen its grip on the economy by slashing rates by a percentage point, according to Fed officials’ best guess. Further rate cuts could be in store for 2025.

Powell also said the question now is how high the Fed will need to raise rates to put inflation on the right path. After that, policymakers will consider how long they need to hold them there.

“I’d say the most important question now is no longer the speed” at which the central bank continues to raise borrowing costs, he said.

President Joe Biden has held out the hope that the economy can avoid a recession next year. Biden hailed the latest Consumer Price Index report released this week, noting that it’s “the fifth month in a row where annual inflation has fallen in the United States.

“Make no mistake — prices are still too high,” he said. "But things are getting better, headed in the right direction.”

Ben White contributed to this report.