There has been some forward movement in controlling continued high inflation in the United States as is being viewed by policymakers at the Federal Reserve which has virtually sealed their strategy of hiking interest rates by a quarter percentage point next week. AT the same time, traders anticipated that the hikes will end in March.
The personal consumption expenditures (PCE) price index, the favourite inflation benchmark of the US central bank, soared 5.0% year on year in December, slower than the 5.5% 12-month gain in November, accoridng to a report by the US government on Friday. This was also the lowest level for the benchmark since September 2021.
Core PCE, which the Fed uses to assess the underlying momentum of inflation by excluding volatile components, increased 4.4% year on year, the slowest rate since October 2021. On an annualized basis, the most recent three-month average increased by around 3.2%.
The Fed’s most aggressive policy tightening since the 1980s, designed to dampen demand across the economy in order to bring inflation back down to its 2% target rate, is expected to end soon, according to traders.
“The Fed can legitimately downshift the pace of rate hikes next week as inflation cools,” said Jeffrey Roach, chief economist at LPL Financial.
The Fed’s policy rate futures are pricing in a near certainty that the central bank will raise its benchmark rate to 4.5%-4.75% at the end of its Jan. 31-Feb. 1 meeting, up from 4.25%-4.5% now, with another quarter-point hike priced in for March.
Other pricing data is also catching up. Inflation expectations for the coming year in the United States have dropped to levels not seen since April 2021, according to a survey released later on Friday. The University of Michigan reported that one-year inflation expectations fell to 3.9% in January from a preliminary reading of 4.0%. The five-year inflation forecast has also been reduced to 2.9% from 3.0%.
Fed policymakers have signaled that they expect interest rates to eventually rise to just over 5%, and have warned that they do not expect to cut rates this year to ensure they win the war on inflation.
However, traders see only a one-in-three chance of another quarter-point increase after March, and following the government report, which also showed consumers cutting back on spending, they increased their bets on rate cuts beginning as early as September.
Because consumer spending accounts for more than two-thirds of economic activity, signs of slowing economic growth, combined with manufacturing in the early stages of a downturn, raises the risk of a recession in the second half of the year.
While the central bank maintains that rates will remain at their current levels for some time, it is expected to buck if inflation continues to fall while the economy sags too much as a result of its monetary tightening.
“With higher interest rates evidently weighing heavily on demand now, we expect core inflation to continue moderating this year, which will eventually persuade the Fed to begin cutting interest rates late this year,” said Paul Ashworth, chief north America economist at Capital Economics.
(Adapted from Reuters.com)
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