In its most recent September meeting, the Federal Reserve opted against proceeding with a new rate increase, citing economic data indicating a decrease in inflation levels. This decision has raised speculation about whether the Fed, along with other central banks, will pause further interest rate hikes for the remainder of the year.
Recent months have witnessed a slowdown in core inflation indicators in both the United States and Europe, as development that could potentially influence the decisions of central banks, leading them to keep interest rates at their current levels.
In August, the core personal consumption expenditure prices in the U.S., which serve as the Fed’s primary gauge of inflation and exclude the volatile food and energy sectors, saw a minimal 0.1 percent increase. This marks the smallest rise since late 2020. Similarly, the eurozone’s comparable index showed the lowest annual increase in a year.
This data provides a basis for policymakers to consider abstaining from implementing any rate hikes during their upcoming meeting in November.
However, policymakers at the U.S. Central Bank’s Federal Open Market Committee (FOMC) have indicated in their latest economic projections that they anticipate another interest rate increase within the current year.
If approved, this move would raise the Fed’s key interest rate to its highest level in 22 years, shifting it from 5.5 percent to 5.75 percent. Nonetheless, this could potentially mark the final adjustment. According to the latest Fed projections, only one official foresees the possibility of additional interest rate increases beyond this point.
Despite Fed officials acknowledging some progress in price stabilization, the task remains far from complete. In August, inflation continued to accelerate for the second consecutive month, resulting in a year-on-year increase of 3.7 percent. The U.S. Bureau of Labor Statistics noted that more than half of this increase could be attributed to surging gasoline prices, which experienced their most significant surge since March.
Fluctuations in food and energy prices can introduce increased volatility to the overall inflation level. However, if these prices persistently rise for an extended period, it could raise concerns for the Fed.
Fed Chairman Jerome Powell emphasized the impact of food and energy inflation on households, highlighting that they bear the major consequences. Consequently, households play a significant role in shaping future price expectations.
Furthermore, Powell reiterated that the rate at which prices, excluding food and energy, are rising (referred to as “core” inflation) serves as the most reliable gauge of underlying inflation. Despite this measure decreasing by over 2 percentage points from its peak, it still exceeds the Fed’s target by more than double. This provides an additional reason for Fed officials to exercise prudence and maintain a cautious approach.
What does Powell’s statement indicate?
According to analysts, the perceived risks of an imminent economic downturn are deemed concerning, particularly in light of historical precedent. They emphasize the Fed’s inadequate efforts in managing the economy and tackling inflation during the 1970s, which ultimately led to a severe recession in the 1980s.
With this in mind, Powell’s statement during his extensive conference following the FOMC meeting becomes understandable. He underscored the critical need to restore price stability and pointed to clear historical evidence indicating that a failure to do so could usher in a challenging period characterized by persistent inflation. This, in turn, could necessitate the Federal Reserve to repeatedly implement and tighten its policies.
Signs of slowdown
While there is ample evidence of a deceleration in the U.S. economy, the current state does not appear to be a cause for immediate concern. Despite the Fed incrementally raising interest rates by a total of 525 basis points since March 2022, unemployment rates continue to hold at historically low levels, and employers are creating a sufficient number of jobs to accommodate the expanding workforce.
Fed officials maintain an optimistic outlook, seeing this as a sign of their capability to slowly mitigate price hikes without detrimental effects on the labor market. Nonetheless, the primary apprehension remains that these measures might possibly exacerbate inflation further.
Read: FED’s message slams U.S. financial markets
The Eurozone
The eurozone witnessed a decline in the annual core inflation rate to 4.5 percent in September, marking the slowest pace recorded in a year. This development strengthens the expectation that the European Central Bank (ECB) will maintain its current interest rates to evaluate the impact of its exceptional measures aimed at tightening monetary policy.
Surprisingly, the ECB chose to raise the main interest rate despite the prevailing expectation of a continued decline in inflation within the eurozone.
In contrast, the Bank of England once again followed the Fed’s recent decision to keep rates unchanged.
Before the year ends, there are two potential opportunities for interest rates to rise in the U.K., as financial markets predict an increase from 5.25 percent to 5.5 percent. However, factors such as inflation expectations, the potential for a recession, the state of the labor market, and the repercussions of rate adjustments by the Fed on other economies all suggest that if interest rates are not lowered, the ongoing pause may need to be extended beyond two months.
In different parts of the world, particularly in East Asia, there has been a notable decrease in inflation, and it is expected to continue at a low level. Despite the U.K. experiencing higher inflation compared to the U.S., eurozone, and Japan, it is also on a downward trajectory.
The decisions made by the Fed undoubtedly have worldwide ramifications. Research suggests that monetary policy decisions have indirect effects on the global stage, influencing exchange rates and long-term borrowing costs due to the impact of higher interest rates. If the BoE, ECB and other central banks overreact to these spillover effects on their economies, there is a potential risk of excessively tightening monetary policy, which could lead to a recession.
Central banks seem to be engaged in a race to increase interest rates. The U.S. has been leading this trend, but it might be advisable to consider pausing the Fed’s tightening cycle, as higher interest rates are unlikely to benefit the global economy.
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