Slowing Inflation Metric Could Place Fed in Challenging Spot Regarding Further Rate Hikes

Federal Reserve Board Chairman Jerome Powell speaks during a news conference following a meeting of the Federal Open Market Committee at the headquarters of the Federal Reserve in Washington, D.C., on Sept. 21, 2022. Drew Angerer/Getty Images

With the latest economic data pointing to a decline in overall annual inflation, debates will intensify within the Federal Reserve on how to move forward with its interest rate hikes.

The 12-month Consumer Price Index (CPI) has remained above 7 percent every month since the beginning of the year. The Fed has pushed up its benchmark interest rate from 0.25 percent in January to a range of 3.75–4.0 percent by November through six straight rate increases, including four hikes of 75 basis points. The November CPI came in at 7.1 percent, down from the peak of 9.1 percent in June. The Fed is currently engaged in its two-day December meeting that began Tuesday in Washington.

The central bank had earlier indicated that it plans to raise rates by only 50 basis points, deviating from the 75 basis-point hikes.

The recent inflation data is expected to intensify the Fed debate over the size of rate hikes in the coming months. The central bank has to carefully consider whether to increase, reduce, or stop the hikes by estimating whether the falling inflation trend will continue in the coming months or not. A wrong decision on rate hikes can have an adverse effect on the economy.

“After this data, I could certainly see the dovish camp pushing more forcefully for slowing the pace of hikes to 25 basis points as quickly as possible,” Aneta Markowska, chief economist at Jefferies LLC, told The Wall Street Journal.

According to the interest rate futures market tracked by the CME Group, the possibility of the Fed raising interest rates by only 25 basis points in February rose from 35 percent on Monday to 56 percent by late Tuesday.

In a recent note, analysts at JP Morgan predicted the Fed to end its rate hike policy by the second quarter of 2023.

“With inflation continuing to fade and fiscal policy likely on hold, the Fed is likely to end its tightening cycle early in the new year and inflation could begin to ease before the end of 2023,” the note said, according to CNN. The analysts are expecting two 25 basis-point hikes in the first half of next year.

The Inflation Issue

Although annual inflation rate has eased in the past months, it still remains considerably elevated, and poses a significant challenge to the American economy. In an interview with Reuters, Venu Krishna, head of U.S. equity strategy at Barclays in New York, pointed out that the trend of easing CPI needs to be sustained.

“There is a big question mark whether we can really come to the 2 percent inflation [Fed target]. Perhaps we live in a world in which it will be higher and that means rates will be higher,” he said.

In addition, the inflation rate for daily essentials remains high, thereby putting strong financial pressure on consumers. Annual food inflation for November was at 10.6 percent while that of energy was 13.1 percent.

Excluding food and energy, annual inflation still registered 6 percent. Inflation in new vehicles rose by 7.2 percent, medical care commodities by 3.1 percent, shelter by 7.1 percent, transportation services by 14.2 percent, and apparel by 3.6 percent.

In an interview with Forbes, Nancy Davis, founder of Quadratic Capital Management, notes that even though the lighter CPI inflation reading is good news, the Federal Reserve still has a long way to go when it comes to tackling inflation.

“While it is certainly possible that we have now passed peak inflation, if we keep up this pace of decline, price increases will continue at levels that are still very painful for consumers,” Davis said while confirming that she expects the Fed to raise interest rate by 50 basis points in its December meeting.