WASHINGTON (AP) — The Federal Reserve signaled Wednesday that it is close to a long-awaited shift toward lower interest rates, a sign that its officials are becoming confident they are close to fully taming inflation. But the Fed also indicated that the first rate cut is likely months away.
The central bank kept the key interest rate unchanged at about 5.4%, the highest level in 22 years. In a statement, it marked a policy shift by dropping previous language that said it was still considering further rate hikes.
However, the Fed warned that it “does not expect it will be appropriate” to cut interest rates “until it gains greater confidence that inflation is moving sustainably” toward its 2% target. This indicates that the interest rate is unlikely to be cut at its next meeting in March.
“I don't think it's likely that the committee will reach a level of confidence by the time of the March meeting” to start cutting interest rates, Committee Chairman Jerome Powell said at a news conference.
The sweeping changes in the Fed's statement on Wednesday – compared to its last meeting in December – show it has moved toward considering interest rate cuts while maintaining flexibility. In December, officials indicated they expected to implement three quarter-point rate cuts in 2024. However, they said little about when these cuts might begin. Senior officials stressed that the Fed would move cautiously.
The central bank's message — that it is close to cutting interest rates but does not plan to do so anytime soon — disappointed Wall Street traders. Stock prices fell broadly after the statement was issued and while Powell was speaking to reporters.
The Fed's change in stance comes as the economy shows surprising resilience after a series of 11 interest rate increases helped significantly slow inflation, which reached its highest level in four decades 18 months ago. Over the past six months, prices have risen at an annual rate of just under 2%, which is in line with the Federal Reserve's target level, according to its preferred measure of inflation. Growth remains healthy. The government said last week that the economy grew at an annual rate of 3.3% in the last three months of last year.
The Federal Reserve is assessing inflation and the economy at a time when the intensifying presidential campaign is centered in large part around voters' perceptions of President Joe Biden's economic management. Republicans in Congress attacked Biden because of the high inflation that swept the country beginning in 2021 as the economy emerged from recession. But the latest economic data — ranging from flat consumer spending and strong job growth to slowing inflation — has been serving to boost consumer confidence.
In his press conference, Powell said the Fed welcomes signs of economic strength. But he said policymakers were looking for more evidence of a continuing slowdown in inflation.
“We want to see strong growth and a strong labor market,” the Fed Chairman said. “We are looking for inflation to fall, as it has been falling over the past six months.”
Most economists said they expect the Fed to begin cutting its benchmark interest rate in May or June. Lowering interest rates would ultimately lead to lower borrowing costs for America's consumers and businesses, including mortgages, auto loans and credit cards.
One year ago, many analysts were predicting that widespread layoffs and sharply rising unemployment rates would be necessary to cool the economy and curb inflation. However, job growth remained steady. The unemployment rate, at 3.7%, is not much higher than its lowest level in half a century.
Labor costs are also falling. On Wednesday, the government reported that wages and benefits for American workers, which accelerated in 2022, grew in the last three months of 2023 at the slowest pace in two and a half years.
The Fed appears on the verge of a rare “soft landing,” where it can ride out high inflation without causing a recession. However, if the pace of economic growth strengthens, this could complicate the Fed's challenge. A much faster expansion, especially one fueled by interest rate cuts, is likely to reignite inflation.
On the other hand, any evidence that the economy is slowing significantly would likely accelerate the Fed's timeline for cutting interest rates. Already, some cracks in the labor market are beginning to appear, and if they worsen, they could prompt the Fed to cut interest rates quickly.
“If we see unexpected weakness in the labor market, that will certainly impact the reduction sooner,” Powell said in his press conference. “If we see inflation becoming firmer or higher, that will be justification for action later.”
Asked whether he believed the Fed had already achieved a soft landing, Powell indicated that it would be too early to say so.
“We have a ways to go,” he said. “Core inflation remains well above target on a 12-month basis. Certainly, I'm encouraged and we're encouraged by the progress, but we're not declaring victory at this stage. We think we have a ways to go.”
For months, most of the country's job growth occurred in just a few sectors — health care, government, hotels, restaurants and entertainment. Any weakness in those areas of the economy could threaten employment and overall expansion.
The number of workers who quit in December reached a three-year low, a report showed Tuesday. This indicates that fewer Americans are being hired for new, higher-paying jobs or are willing to search for and hold new jobs. Although smoking cessations remain at a level consistent with a strong labor market, they have fallen by about a third from their peak in mid-2022.
However, the US economy is outperforming its counterparts abroad. From October to December, the 20 countries that use the euro barely avoided recession and recorded essentially no growth. However, as in the United States, unemployment rates are very low in the eurozone, and inflation has slowed to an annual rate of 2.9%. Although the European Central Bank could cut interest rates as soon as April, many economists believe that may not happen until June.
