The Federal Reserve said on Wednesday that it had turned a key corner in the fight against high inflation, but that “victory” would still necessitate raising its benchmark overnight interest rate further and keeping it there at least until 2023.

In announcing its latest policy decision, the US central bank scaled back to a quarter-point rate increase after a year of larger hikes, and brushed aside in its statement the long list of reasons driving up prices, from war to pandemic, to say simply that “inflation has eased.”

However, policymakers projected “ongoing increases” in borrowing costs, an open-ended commitment that did not yet specify when the rate hikes might stop, and pushed back against financial markets’ expectations that the Fed would pause soon and, indeed, cut rates later this year.

Nonetheless, investors took a dovish cue from Fed Chair Jerome Powell, who repeatedly mentioned the “disinflationary” process that appeared to be underway during a news conference. As Powell spoke, equity markets rose, and investors increased their bets on future rate cuts.

Meanwhile, Powell insisted that no rate cuts are planned and took pains to walk what has become an increasingly fine line between the flow of data showing steady declines in inflation and the need to keep the public and investors aware that interest rates will continue to rise.

“We can now say for the first time that the disinflationary process has started,” Powell told reporters after the end of the Fed’s latest two-day policy meeting, with goods prices slowing, pandemic-related shortages easing, and supply chains getting back to normal. “This is a good thing.”

From a high of nearly 7% in June, the Fed’s preferred measure of inflation fell to 5% in December, still well above its 2% target but steadily improving.

Yet “it’s just the early stages,” Powell said. “We’re going to be cautious about declaring victory and … sending signals that we think that the game is won, because we’ve got a long way to go.”

Important sectors of the economy, including large swaths of the service sector, have yet to see inflation slow, according to the Fed chairman, while a high level of job openings and continued strong wage increases indicated the labor market was “extremely tight.”

“The labor market continues to be out of balance,” Powell said, flagging the fact that Fed officials feel it is likely that the unemployment rate will need to rise from its current low level of 3.5% for inflation to complete the journey back to the 2% level.

The Fed’s statement on Wednesday was its first explicit acknowledgement of slowing inflation after a year in which prices accelerated much faster than expected, necessitating a series of rapid three-quarters-point and half-point rate increases to match the outbreak of rising prices.

US Federal Reserve Chair Powell speaks at a news conference in Washington after the Fed revealed a quarter-point interest rate hike. Dynamics that the Fed has said were causing prices to rise in the past year, including the pandemic, were either dropped from the statement entirely or, in the case of the Ukraine war, cited only as a source of “global uncertainty” rather than inflation.

The Fed’s rate hikes since March have totaled 4.5 percentage points, with the policy rate now ranging between 4.50% and 4.75%, the highest level since 2007. This is reflected in a variety of consumer borrowing costs, including home mortgages and car loans.

The full impact of that monetary policy tightening has yet to be felt in the economy, but it has so far been absorbed without derailing the Fed’s latest statement’s “modest” economic growth and “robust” job gains.

It is partly because of this resilience that the central bank expects “ongoing increases” in its policy interest rate.

With inflation still high and economic demand stronger than many expected, Powell said it is unclear how much higher rates will need to go. As of December, Fed policymakers projected a peak policy rate of 5.00% to 5.25%, which is consistent with what Powell said during his news conference as an aside that there would likely be a “couple” more rate hikes to come.

Stocks, which had been slightly lower ahead of the Fed rate decision, surged as Powell spoke. The benchmark S&P 500 index finished the day up slightly more than 1%.

At the same time, the yield on the 2-year Treasury note, the maturity most sensitive to Fed policy expectations, fell sharply and was trading more than 10 basis points lower at 4.10%. The value of the US dollar fell against a basket of major trading partner currencies.

“If you were hoping for clear signs of an upcoming pause in interest rate hikes, you were left wanting. The Federal Reserve retained the phrase ‘ongoing increases’ in their statement, leaving their options open depending on what upcoming economic data says,” said Greg McBride, chief financial analyst at Bankrate.

(Adapted from CNBC.com)

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