Fed may raise rates higher than expected to beat inflation

Federal Reserve officials have enough worrisome inflation data to consider raising interest rates to the highest levels investors are expecting and likely following the half-point hike they signaled this month with a similar increase in February.

Monthly wages rose at their strongest pace since January and US employment grew more than forecast last month, a report showed on Friday. That should worry Fed Chairman Jerome Powell, who this week warned that slowing job market conditions and weaker earnings growth are needed to cool the inflation rate near its highest level in recent years. 40 years.

Powell and his colleagues, currently in a blackout ahead of the meeting, have strongly suggested that they drop to a half-point increase at the December 13-14 meeting, after four 75 basis point gains. consecutive version. He also said they will likely need higher interest rates than they thought they would in September, when the median forecast sees them at 4.6% next year from the current target range of 3.75% to 4%.

Rhea Thomas, senior economist at Wilmington Trust Co. highest rate and is likely to keep it in place longer.

Bets on a drop to the half-point gain this month remained intact following the jobs report, and investors saw the possibility of the same thing happening again at the Fed’s Jan. Feb. 1 meeting as roughly balanced. Valuations in the futures markets see interest rates peaking at around 4.9% next year.

Officials will update their quarterly forecasts at the December meeting and could raise their average forecast for next year’s peak in interest rates to 5% or higher. Fed President St. Louis James Bullard has called for a minimum peak of 5.25% and several analysts, including Diane Swonk, chief economist at KPMG LLP, sees interest rates as high as 5.5%, with the Fed poised to trigger a recession if necessary to restore price stability.

Inflation ‘metastasizes’ if left untreated

“Inflation is like a cancer: if left untreated, it metastasizes and becomes much more chronic,” says Swonk. A higher “cure” rate means “the year 2023 will be very difficult.”

Fed officials will receive an additional consumer price report before the December meeting and have an extra month of data to review before they collect it again early next year.

Powell on Wednesday said the wage hike could be a “very important part of the story” on inflation. While supply chain difficulties for goods appear to be easing, supporting the pricing outlook in that sector, he said wages are the biggest expense for the services sector, so Labor conditions are key to understanding the price outlook for everything from hotels to haircuts.

The jobs report showed average hourly earnings rose 0.6 per cent in November, the biggest wide-ranging increase since January and up 5.1 per cent from a year earlier. Wages for production and non-supervisory workers rose 0.7 percent month-on-month, the highest in nearly a year. The pace of wage growth is not in line with the Fed’s 2% inflation target.

Vincent Reinhart, chief economist at Dreyfus and Mellon, said: “Pressures remain on the labor market and if anything is as bad as they have been. “They want a little more restraint really because they believe — at least as Powell believes — inflationary pressures are ingrained in the consumer price basket.”

While central banks set growth targets below trend to ease price pressures, the addition of 263,000 jobs last month — leaving unemployment at 3.7% — is fresh evidence. shows that the US economy is still resilient. According to the Atlanta Fed’s tracking estimates, fourth-quarter growth is likely to be 2.8%, much higher than estimates for what’s sustainable over the term.

While Fed leaders have suggested there is scope for a 50 basis point correction this month, they have sought to shift investors’ focus to where interest rates peak from the size of banks. moves to be made at each meeting.

They also emphasized the cumulative impact of previous increases and the view that policy has lag. That encouraged speculation that they could drop to 25 basis points next year to reduce the risk of them going too far.

Even so, the latest jobs report could prompt officials to consider another 50 basis points early next year.

“The Fed – and especially Powell – is very focused on the sources of labor market-induced inflation, and this report should make the headlines,” said Thomas Costerg, senior US economist at Pictet Wealth Management. he is on high alert. “I think they could go on with another 50 at the next Fed meeting.”

‘This labor shortage has helped fuel inflation’

The workforce is growing much more slowly than expected, with 3.5 million fewer workers than expected after Covid-19 spurred early retirement and changed working patterns starting from 2020. That’s not going to change any time soon.

“This labor shortage has helped feed inflation,” Richmond Fed President Thomas Barkin said on Friday, and with baby boomers retiring, that could be continue in the long term. Although the Fed was quick to raise rates, “we see labor demand continuing to outstrip supply,” he said.

At the upcoming meeting, Fed officials may also want to emphasize their insistence on higher interest rates to counter Wall Street, which has responded to the planned deceleration with easing of restrictions. Financial lawsuits may not be welcome. The Fed has deliberately tightened conditions to reduce demand and ease price pressures.

“Broader financial conditions are becoming easier. It’s not clear to me that the Fed is making much progress.” Stephen Stanley, chief economist at Amherst Pierpont Securities LLC. “The Fed still has a lot of work to do to cool down enough of the economy and especially the labor market enough to achieve the desired level of inflation. We are definitely not there yet.”

—With support from Rich Miller.

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