Fed minutes show inflation is making progress, but there is no rush to cut rates

Federal Reserve officials welcomed a recent slowdown in inflation at their last meeting in late January but were determined to tread carefully as they tiptoed toward rate cuts, the U.S. central bank said. minutes after that meetingthat were released on Wednesday.

Central bankers raised interest rates sharply between March 2022 and July 2023, taking them to 5.3 percent from a starting point of near zero. These measures were intended to cool consumer and business demand, which officials hoped would slow rapid inflation.

Now inflation is slowing down significantly. Consumer prices rose 3.1 percent over the year to January, a sharp decline from their recent peak of 9.1 percent. But that's still faster than the pace that was normal before the pandemic, and it's above the central bank's target: The Fed aims for 2 percent inflation over time using a different but related measure, the Personal Consumption Expenditures Index.

The economy has continued to grow at a strong pace, even though price growth has been moderate. Hiring has remained stronger than expected, wage growth continues and retail sales data suggests consumers are still willing to spend.

That combination has Fed officials thinking about when — and how much — to cut rates. While central bankers have made clear that they do not think they need to raise borrowing costs further at a time when inflation is moderating, they have also suggested that they are in no rush to cut rates.

“Significant progress has been made recently in returning inflation to the committee's long-term target,” Fed officials reiterated in their newly released minutes. Officials believed lower rents, an improving labor supply and productivity gains could all help moderate inflation further this year. Policymakers also suggested that “upside risks to inflation” had “reduced” – indicating that they are increasingly confident that inflation is falling sustainably.

But they also identified risks that could drive up inflation. In particular, participants noted that momentum in aggregate demand could be stronger than currently estimated, especially in light of surprisingly resilient consumer spending last year.

When policymakers last released their economic projections in December, their forecasts suggested they could cut interest rates by three quarter points this year, to about 4.6 percent. Investors are bet now that interest rates will be around 4.4 percent in 2024, although there is a feeling that this could be slightly higher or lower.

As they consider the future of policy, Fed policymakers must weigh competing risks.

Leaving rates too high for too long risks slowing growth even more than officials want — a concern raised by “a few” officials at the Fed meeting in late January. Too tight a policy could increase unemployment and even lead to a recession.

On the other hand, a premature rate cut could give the impression to markets and ordinary Americans that the Fed is not serious about reducing inflation until it returns to full normal. If price increases were to pick up again, it could be even more difficult to suppress them in the long term.

“Most participants noted the risks of moving too quickly to soften the policy stance,” the minutes said.

Policymakers are also considering when to stop shrinking their bond holdings so quickly.

Officials have bought a lot of government bonds and mortgage-backed debt during the pandemic, first to calm troubled markets and later to stimulate the economy by making longer-term borrowing cheaper. That increased the size of the Fed's balance sheet. To return these assets to more normal levels, officials have allowed securities to mature without reinvesting the proceeds.

But central bankers want to tread carefully: If they adjust the balance sheet too quickly or too much, they risk disrupting financial markets. In fact, that happened in 2019 after a similar process.

Policymakers decided at their meeting that “it would be appropriate” to begin in-depth discussions on the balance sheet at the Fed's next meeting, due in March – with some suggesting it could be useful to slow the pace of the contraction to delay. and that this “could enable the committee to continue the balance sheet reduction for a longer period of time.”