Federal Reserve Raises Interest Rates by Quarter-Point, Signals Further Rate Hikes

Federal Reserve Board Chairman Jerome Powell speaks during a news conference after a Federal Open Market Committee meeting in Washington on Feb. 1, 2023. Kevin Dietsch/Getty Images

The Federal Reserve raised interest rates by 25 basis points, matching market expectations and lifting the benchmark federal funds rate to a target range of 4.50 to 4.75 percent.

This was the smallest rate increase since the current quantitative tightening cycle began in March 2022.

Central bank officials believe that further increases will be necessary to obtain “a stance of monetary policy that is sufficiently restrictive,” according to a statement from the Federal Open Market Committee (FOMC). While inflation has slowed, it remains too high for the U.S. economy.

“Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation has eased somewhat but remains elevated,” the FOMC stated.

“Russia’s war against Ukraine is causing tremendous human and economic hardship and is contributing to elevated global uncertainty. The Committee is highly attentive to inflation risks.”

However, when determining the size and pace of future rate hikes, policymakers will consider policy lags, economic and financial developments, and cumulative tightening in their decision-making.

The rate-setting committee will continue trimming its holdings of Treasury securities, agency debt, and agency mortgage-backed securities.

“The Committee is strongly committed to returning inflation to its 2 percent objective,” the statement reads.

The market had widely anticipated that the FOMC would overwhelmingly agree to a quarter-point rate increase amid cooling inflation and a slowing U.S. economy.

Financial markets on Feb. 1 finished higher after a volatile session. The U.S. Dollar Index, which measures the greenback against a basket of currencies, tumbled by 0.25 percent to below 102. The U.S. Treasury market was mixed, with the benchmark 10-year yield down by nearly 5 basis points to about 3.42 percent.

“Those hoping for a change to the ‘ongoing increases’ phrase are disappointed as the Fed is not ready yet to signal an imminent end to the hiking cycle,” prominent economist Mohamed El-Erian wrote in a tweet.

What’s Next for the Federal Reserve?

Following the FOMC announcement, U.S. rate futures are penciling in an 85 percent chance of a quarter-point hike at next month’s policy meeting. There’s also a 15 percent chance of a rate pause.

While economists and market analysts have purported that it might be time to hit the pause button to determine how 15-year-high interest rates are impacting the broader economy, Federal Reserve officials are debating how much higher the federal funds rate should go, especially as the institution nears the end of its quantitative-tightening cycle.

Since November 2022, investors have been fighting the Fed, insisting that the central bank will reverse course and begin cutting rates later this year in response to slowing economic conditions. However, Fed Chair Jerome Powell has repeatedly stated that the Summary of Economic Projections (SEP) is a better indicator of where the benchmark rate could go in 2023.

According to the SEP, policymakers expected the median rate to be 5.1 percent this year.

Many rate-setting FOMC members have contended that it’s too soon to say that inflation is over.

While speaking during a recent interview with The Associated Press, Loretta Mester, president of the Federal Reserve Bank of Cleveland, made the case that the central bank needs to keep going and lift the chief policy rate to at least 5 percent.

Esther George, departing president of the Federal Reserve Bank of Kansas City, told Reuters that interest rates need to rise more, although she would be satisfied with smaller increments.

“People’s expectations about inflation are beginning to move down. So I’m comfortable beginning that stepped-down process ... I’d be happy to do 25s [basis points] if I were there,” she said. “We still have upside risk to inflation. I don’t think I’ve reached a point where I think it is clearly falling. There are enough issues out there to say we have to guard against them.”

Whatever course of action the central bank takes, Fed Vice Chair Lael Brainard said in a speech at the University of Chicago Booth School of Business last month that policymakers need to keep rates high for a prolonged period.

“Even with the recent moderation, inflation remains high, and policy will need to be sufficiently restrictive for some time to make sure inflation returns to 2 percent on a sustained basis,” Brainard said. ”The FOMC moved policy into restrictive territory at a rapid pace and, subsequently, downshifted the pace of increases in the target range at its most recent meeting. This will enable us to assess more data as we move the policy rate closer to a sufficiently restrictive level, taking into account the risks around our dual-mandate goals.”

A Look at the Data

In December 2022, the annual inflation rate eased to 6.5 percent, and the core Consumer Price Index (CPI), which excludes the volatile energy and food sectors, eased to 5.7 percent.

The Personal Consumption Expenditures (PCE) price index—the Fed’s preferred inflation gauge—also slowed to 5 percent year-over-year in December 2022. The core PCE price index fell to 4.4 percent.

Various economic metrics haven’t been inspiring. Personal spending tumbled by 0.2 percent in December 2022, while personal income edged up by 0.3 percent. The manufacturing indexes from the Federal Reserve banks of Kansas City, Dallas, and Richmond all remained in contraction territory. The Conference Board Leading Economic Index (LEI), which is considered to be a leading recession indicator, fell by a larger-than-expected pace of 1 percent in December 2022.

In its first forecast for the first quarter of 2023, the Atlanta Fed Bank’s GDPNow model estimate suggests 0.7 percent growth in the upcoming January-to-March period.