WASHINGTON — Federal Reserve officials on Wednesday made their eighth interest rate increase in a year and signaled at least two more to come as they continue their fight against rapid price gains. But they approved a smaller increase than in the past and acknowledged that inflation had finally started to meaningfully ease.
The central bank concluded its first meeting of 2023 by announcing a quarter-point rate increase, the smallest adjustment since March. The Fed’s policy rate is now set to a range of 4.5 to 4.75 percent, up from near zero a year ago.
Wednesday’s move marked a major slowdown from last year, when the Fed lifted borrowing costs at the fastest pace since the 1980s in a bid to tamp down soaring inflation. Price gains have now moderated, with the Fed’s preferred inflation index at 5 percent in December, down from a peak of nearly 7 percent in June.
With interest rates already elevated, central bankers are adjusting policy gradually as they wait to see how their higher borrowing costs are affecting consumers and businesses. Incoming economic readings will help determine how high the Fed ultimately lifts rates and how long it keeps them there.
Jerome H. Powell, the Fed chair, made clear during his news conference on Wednesday that the central bank planned to be cautious about declaring victory over inflation. He said “a couple more” rate increases were under discussion to make sure that price pressures came firmly and fully back under control.
“We can now say, for the first time, the disinflationary process has started,” Mr. Powell said, but he later added: “We will stay the course until the job is done.”
Despite that, Wall Street welcomed Mr. Powell’s statements on Wednesday as a sign that the Fed may stop lifting rates very soon — after March. Stocks surged as he spoke, and expectations that the central bank will end its adjustments after one more rate move solidified. Market pricing also suggested that investors had nudged up the chances that the Fed would cut rates notably by the end of the year. The S&P 500 rose 1 percent, adding to a rally that has lifted shares more than 7 percent this year.
The disconnect between the Fed’s statements and investor expectations ties back in part to what is actually happening in economic data versus what is projected to happen next. Many forecasters expect the labor market, as well as inflation in many kinds of services, to weaken this year as the full effect of the Fed’s rate moves plays out; the Fed, on the other hand, is waiting for clearer signs in the data.
The Fed’s decision amounted to a shift to a more cautious period of inflation fighting. Its policymakers are welcoming the recent slowdown in price increases, and the disinflation trend gives them more room to tread carefully as they make further policy adjustments. But central bankers are worried that some portion of today’s inflation could prove difficult to stamp out entirely, which is preventing them from halting the assault altogether.
“We’ve moved into a new phase of policy,” said Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives. “The committee is no longer playing catch-up.”
Central bankers projected in December that they would raise interest rates to just above 5 percent in 2023 — implying two more quarter-point increases after this week’s move — and leave them there through the year. Those higher borrowing costs would make it more expensive to finance a car or expand a business, slowing demand and helping to bring the economy back into balance.
Officials reiterated in their statement on Wednesday that “ongoing” rate increases were likely to be appropriate. But Mr. Powell said no decisions had yet been made about how high rates would go.
At times, Mr. Powell hinted that the central bank still expected to raise rates to just above 5 percent and then leave them there throughout 2023.
“We’re talking about a couple more rate hikes to get to that level we think is appropriately restrictive,” he said. He later added that he did not expect to cut rates this year if the economy performed as expected.
Mr. Powell also noted that he did not “feel a lot of certainty” about where rate increases would stop and that “it could certainly be higher,” and said it was difficult to manage the risk of doing too little and having inflation spring back up. On the other hand, he said, if the Fed went too far, that would be easier to deal with.
“The job is not fully done,” he said.
So far, evidence of labor market moderation in particular remains inconclusive: Initial claims for jobless benefits remain muted, and the unemployment rate is as low as it has been in half a century. Job openings rose in December, and 1.9 positions are now available for every unemployed worker.
“The labor market remains extremely tight,” Mr. Powell said on Wednesday. The Labor Department will release January hiring and unemployment figures on Friday.
That creates a source of tension for the Fed. Officials always expected prices to begin to cool as pandemic supply chain issues cleared and consumers worked through big savings stockpiles and slowed their spending — and that deceleration is showing up. But some policymakers worry that rapid wage growth could keep inflation in services — hotels, restaurants, sporting events — stubbornly higher than it was before the pandemic.
“We saw an acknowledgment that the inflation picture is getting better, but that doesn’t mean that the Fed is close to declaring victory over it by any means,” said Sarah House, senior economist at Wells Fargo.
The global economy is also not as weak as many expected, as a mild winter mitigates energy-related problems in Europe and as China reopens from rolling shutdowns. In their statement, Fed officials nodded to the fact that worldwide growth is less imperiled than it seemed last year, dropping a line that said the war in Ukraine was “weighing on global economic activity.”
Instead, the Fed’s policymakers said the war “is contributing to elevated global uncertainty.”
Such signs of economic resilience could help the Fed to pull off a soft landing, in which it tempers inflation without causing a deep downturn. On the other hand, continued economic strength could shore up demand and keep price increases from moderating sufficiently, if growth proves too robust.
Fed officials will be focused on where the economy is headed — and how much more they think it needs to slow — in the coming months as they determine how high to raise rates and how long they need to leave them elevated.
How much more the Fed ultimately does will be important for Americans everywhere, because it will help decide how much the jobless rate rises this year.
“The risk of a recession is very real at this point,” said Bill English, a former director of the Fed’s monetary affairs division who is now a professor at the Yale School of Management. “They’re walking pretty close to the line in some sense.”
Beth Ann Bovino, chief U.S. and Canada economist at S&P Global Ratings, said the Fed’s plan to reduce the size of interest rate increases indicated that central bankers were “trying to land the plane gracefully.”
But she added that “the impact of cumulative rate hikes come with a lag.”
As of their latest economic forecasts, central bankers expected unemployment to pop to 4.4 percent by the end of the year. That would be up from 3.5 percent now. The central bank will release its next set of economic projections in March.
Mr. Powell said he thought the Fed would be able to wrangle inflation without toppling the economy into a painful recession. But he also reiterated that the central bank was committed to bringing price increases under control, despite the potential cost to growth and the labor market.
“We have to complete the job,” he said. “That’s what we’re here for.”