In response to a stronger-than-anticipated economy and a slower-than-expected decline in inflation, the Federal Reserve left interest rates unchanged on Wednesday but hinted in new projections that borrowing costs may still need to rise by as much as half a percentage point by the end of this year.

In a press conference following the central bank’s most recent policy meeting, Fed Chair Jerome Powell stated that despite the aggressive monetary policy tightening of the previous year, U.S. growth and the job market have held up better than expected. This has likely prolonged the Fed’s battle to lower inflation while also allowing it to proceed with less economic harm.

The Fed paused out of caution, according to Powell, to give it time to gather more data before deciding whether or not rates need to climb again. The pace of the hikes is now less significant than choosing the right endpoint that will reduce price increases while minimising any increase in unemployment.

According to the Fed’s most recent quarterly projections, “growth estimates moved up a bit, unemployment estimates moved down a bit, and inflation estimates moved up,” according to Powell, after a year in which many economists and analysts predicted an impending recession and the economy was ready to collapse.

Together, the statistics indicated that “more restraint will be necessary than we thought,” according to Powell, who was speaking about recent estimates that revealed a consistent upward move in policymakers’ expectations for interest rates this year.

Nine of the 18 officials anticipate an increase in the benchmark overnight interest rate of 0.5% to 0.5% over the current range of 5.00%-5.25%, while three others believe it should increase even further.

The Fed is concentrating on “getting the policy right” as it considers what may be its final rate rises before dropping inflation makes probable rate reduction next year, Powell added, adding that he felt the parts of the inflation puzzle were starting to come together.

“The conditions we need to see … to get inflation down are coming into place,” Powell told reporters, including below-trend growth, a somewhat weaker labor market, and improving supply chains. “But the process of that actually working on inflation is going to take some time.”

It was a gently upbeat message that moderated generally pessimistic predictions that the policy rate would increase faster than market participants had anticipated.

That was no mistake, according to Subadra Rajappa, head of U.S. rates strategy at Societe Generale; the Fed is now keeping its options open in case future rate rises are required, but it’s not committing itself if inflation declines more quickly than expected.

“The ‘dots’ are hawkish, but he did a good job of telling markets not to see it as such,” she said.

In reality, investors in futures linked to the Fed’s policy rate expect the institution to raise rates by just a quarter of a percentage point by year’s end. The probability of a rate increase next month is estimated to be approximately 65%, a small increase from before this week’s meeting.

Powell reiterated the Fed’s normal warning about “upside” risks to inflation, but the decision to maintain the current course also aimed to slow the rate of price increases “with the minimum damage” to the labour market. The updated forecasts indicated that the unemployment rate will climb from its current level of 3.7% to 4.1% by the end of 2023, but that would represent a much lesser increase than the 4.6% official forecast from March.

“Holding the target (interest rate) range steady at this meeting allows the committee to assess additional information and its implications for monetary policy” before taking another step, the central bank’s rate-setting Federal Open Market Committee (FOMC) said in a unanimous policy statement at the end of its two-day meeting.

Powell stated that although though policymakers have not made a decision regarding interest rates, the meeting on July 25–26 is a “live meeting” and could result in another raise.

“This looks like a meeting where the Committee was split, everybody got something, and nobody got everything. A dovish decision, a hawkish statement, and very hawkish dots,” wrote economists at the analytics firm of Larry Meyer, a former Fed governor. “Ultimately … though Powell was vague on many points, we see his press conference as relatively dovish.”

After the policy announcement, U.S. equities declined, but by day’s end, the Nasdaq Composite and the S&P 500 indexes had closed marginally higher. The Dow Jones Industrial Average decreased by 0.68 percent.

With a stronger understanding of the economy and slower progress towards getting inflation back to the central bank’s aim of 2%, the Fed’s higher rate projection makes sense. Right now, it is more than twice that.

Fed experts’ median prediction for 2023 GDP growth more than doubled from 0.4% in March projections to 1%.

By the end of 2023, the core Personal Consumption Expenditures Price Index is projected to fall from its current level of 4.7% to 3.9%, down from the policymakers’ March prediction of a 3.6% year-end rate.

The Fed responded to the worst inflation outbreak in 40 years with a matched set of strong steps, including four outsized increases of three-quarters of a percentage point last year. The policy decision on Wednesday ended a run of 10 consecutive rate hikes.

The policy rate set by the central bank, which affects borrowing costs for individuals and businesses across the economy, increased by a full 5 percentage points from the beginning of the tightening cycle in March 2022, rising to its highest level since shortly before the beginning of the 2007–2009 recession.

(Adapted from AlArabiya.net)

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