WASHINGTON — With the US economy at a pivotal point, Federal Reserve officials on Wednesday paused raising their key interest rate for the first time in 15 months to determine how much more is needed to tame still-high inflation.
But the break probably won’t last for long.
The Fed indicated it plans to raise rates again, starting as early as next month, with the hikes totaling about a half percentage point by the end of the year. The forecast surprised analysts and caused major stock indexes to drop initially on the news before recovering.
With the debt limit crisis over for now and encouraging data recently on inflation and jobs, the Fed had been widely expected to pause the aggressive string of interest rate hikes it began early last year to halt fast-rising prices. Fed officials voted unanimously to do so Wednesday, keeping their benchmark rate between 5 percent and 5.25 percent, well above the near zero percent level before the increases started in March 2022.
Holding the rate steady allows Fed officials to “assess additional information and its implications for monetary policy,” the central bank said in a statement. That would allow them to monitor incoming economic data and take into account the delayed impact of tighter credit conditions from higher rates as they work their way through the economy, such as whether higher mortgage costs cause home sales to slow and reduce home building and construction jobs.
“We’ve covered a lot of ground and the full effects of our tightening have yet to be felt,” Fed Chair Jerome Powell said at a news conference. He added that the process of getting inflation back to normal still “has a long way to go.”
Despite coming down significantly over the past year, inflation remains stubbornly high. In their quarterly projections also released Wednesday, Fed officials don’t expect inflation to return to normal levels until 2025. One reason for that is the Fed now thinks the economy will grow at a slightly faster rate than previously projected — though at a still weak 1 percent rate — and the job market will cool only slightly, with the unemployment rate forecast to rise to 4.1 percent in December, from 3.7 percent last month.
Those changes are positive overall, meaning a recession is not on the horizon and fewer people will lose their jobs. But that’s not a recipe for significantly reducing inflation. The improved economic growth signals that consumers will keep spending. And the continued solid job market means employers will have to raise wages to lure new workers and keep the ones they have.
Those developments would likely push prices higher. So Fed officials projected they would need to raise their benchmark interest rate to 5.6 percent by the end of the year.
The Fed’s rate is a benchmark for consumer and business loans from banks. Higher borrowing costs slow economic growth by reducing spending. That helps reduce inflation but also risks a recession if the slowdown goes too far. The Fed is trying to get that calculus correct and execute what’s known as a soft landing for the economy: raising interest rates just enough to bring inflation back to normal without triggering a recession.
There have been encouraging signs recently that the Fed could pull off that extremely difficult task.
“I’m rooting for a soft landing. I think everybody’s rooting for a soft landing,” said Karen Dynan, a Harvard professor and former Treasury Department chief economist during the Obama administration. “Given the developments this year, it smells a little more possible than it did at the start of the year.”
The government reported this week that a key inflation measure continued to improve after hitting a four-decade high a year ago. The consumer price index rose at an annual rate of 4 percent in May from a year earlier, well off the 9.1 percent clip it peaked at last June. Data released Wednesday morning also showed continued improvement in inflation at the wholesale level. And the labor market remains strong, with 339,000 jobs created in May and the unemployment rate, although rising, remaining below 4 percent.
“The economy’s on the right track,” said Boston College economist Brian Bethune. “I think there’s a window here for the Fed to pause. Inflation’s going in the right direction. The economy is still holding up pretty well . . . and it’s kind of what I would call more of a wait and see thing for two or three months to just observe how things are playing out.”
Avoiding a recession would be a boost to President Biden’s reelection campaign and he trumpeted the new inflation data on Tuesday. But the Fed, which operates independently from the White House, wants annual inflation to run at 2 percent, so there’s still a ways to go to get back to normal. And that means there’s still the risk of a recession before the 2024 election.
Dynan warned that core inflation, which removes food and energy prices to give a less-volatile reading, hasn’t eased for several months. The core consumer price index was 5.3 percent higher in May compared to a year earlier. That indicates consumer demand remains strong and the Fed still might need to raise interest rates more in the coming months, which could push the nation closer to a recession, she said.
“I think it’s probably a tossup as to whether we’ll see a recession later this year or early next year,” Dynan said. “It really depends on the path of inflation.”
Powell echoed Dynan’s concerns about core inflation.
“You’re just not seeing a lot of progress, not the kind of progress we want to see,” he said.
But there’s been enough improvement for Fed officials to take a break from raising interest rates after already ratcheting down the size of those hikes this year from the three-quarter percentage point ones of 2022. Future increases would probably be in small steps of only a quarter percentage point and occur less frequently, Powell said.
“Given how far we have come, it may make sense for rates to move higher but at a more moderate pace,” he said. “It’s reasonable, it’s common sense to go a little slower.”
A majority of the 18 Fed officials who make projections anticipated they would increase the interest rate by a total of half a percentage point by the end of the year. But three projected an increase of three-quarters of a percentage point during that period. None expected the rate to stay where it is.
Diane Swonk, chief economist at audit and consulting firm KPMG, believes those hikes are coming soon. She predicted in a note to her clients after the meeting that the Fed will hike a quarter percentage point at each of its next two meetings in July and September before pausing for the rest of the year.
“The Fed is attempting something that has never been done: Derail a persistent inflation without tipping the economy into a significant recession,” she said. “Powell is more confident than his peers that can be done.”
Jim Puzzanghera can be reached at jim.puzzanghera@globe.com. Follow him @JimPuzzanghera.