Federal Reserve officials welcomed a recent slowdown in inflation at their last meeting in late January, but intended to tread carefully as they move toward rate cuts, according to minutes from the meeting released Wednesday.
Central bankers raised interest rates sharply from March 2022 to July 2023, pushing them to 5.3 percent from a starting point near zero. These moves were intended to reduce consumer and business demand, which officials hoped would reduce runaway inflation.
Now, inflation is slowing down substantially. Consumer prices rose 3.1 percent in the year to January, sharply below their recent high of 9.1 percent. But that’s still faster than the normal pace before the pandemic and is above the central bank’s target: The Fed aims for 2% inflation over time using a different but related metric, the Personal Consumption Expenditure index.
The economy has continued to grow at a steady pace, although price inflation has moderated. Hiring remained stronger than expected, wage growth is accelerating and retail sales data suggest consumers are still willing to spend.
That combination leaves Fed officials mulling over when — and how much — to cut interest rates. While central bankers have been clear they do not believe they need to raise borrowing costs further at a time when inflation is easing, they have also suggested they are in no rush to cut interest rates.
“There has been significant progress recently on returning inflation to the committee’s long-term objective,” Fed officials reiterated in their recently released minutes. Officials thought lower rental prices, improving labor supply and productivity gains could all help inflation moderate further this year. Policymakers also suggested that “upside risks to inflation” had “reduced” – suggesting they are becoming more confident that inflation is coming down sustainably.
However, they also identified risks that could increase inflation. Specifically, “panelists noted that aggregate demand dynamics may be stronger than currently appreciated, especially in light of surprisingly resilient consumer spending last year.”
When policymakers last released economic projections in December, their projections suggested they could cut interest rates by three quarters this year, to about 4.6 percent. Investors are now betting that rates will finish 2024 at around 4.4%, although there is some sense that they could end up slightly higher or lower.
As they think about the future of policy, Fed policymakers must balance competing risks.
Keeping interest rates too high for too long would risk slowing growth more than officials want — a concern expressed by “some” officials at the Fed’s late January meeting. Too tight a policy could push unemployment higher and could even trigger a recession.
On the other hand, an early rate cut could signal to markets and everyday Americans that the Fed is not serious about crushing inflation until it fully returns to normal. If price hikes rise again, it would be even harder to hit the road.
“Most participants noted the dangers of moving too quickly to relax the policy stance,” the minutes said.
Policymakers are also considering when to stop shrinking their bond balance sheets so quickly.
Officials bought a lot of government debt and mortgages during the pandemic, first to calm troubled markets and later to stimulate the economy by making even longer-term borrowing cheaper. This swelled the size of the Fed’s balance sheet. To reduce these holdings to a more normal level, officials allowed the securities to expire without reinvesting the proceeds.
But central bankers want to tread carefully: If they adjust the balance sheet too quickly or too much, they risk upsetting the hydraulics of financial markets. In fact, this happened in 2019 after a similar process.
Policymakers decided at their meeting that “it would be appropriate” to begin in-depth balance sheet discussions at the Fed’s next meeting in March — with some suggesting that slowing the pace of contraction might be helpful and that doing so “could allow the committee to continue to run down the balance sheet for longer.”
