U.S. Federal Reserve officials left interest rates unchanged on Wednesday, but signalled support for one more rate increase this year and fewer rate cuts next year as the American economy proves more resilient than expected.
Federal Open Market Committee members voted unanimously to hold the benchmark Federal Funds rate between 5.25-5.5 per cent, the highest level since 2001. This is the second time the Fed has held off raising interest rates this year, as it inches toward the end of its historic campaign of monetary policy tightening aimed at getting inflation under control.
At the same time, new projections released Wednesday show that the majority of FOMC members expect to increase interest rates one more time before the end of the year, either in November or December. They also expect to keep interest rates higher for a longer period of time, with fewer rate cuts pencilled in over the next two years compared with the previous projection, published in June.
“We’re in a position to proceed carefully at this point,” Fed Chair Jerome Powell said in a news conference after the rate announcement. “A year ago, we proceeded pretty quickly to get rates up. Now we’re fairly close, we think, to where we need to get. It’s just a question of reaching the right stance.”
This echoes the approach taken by the Bank of Canada, which held rates steady earlier this month. On Wednesday, the bank published a summary of the discussions that took place ahead of the Sept. 6 rate decision.
The document shows that Canada’s top central bankers remain unsure whether rates are high enough to get inflation under control, but are trying to balance the risks of doing too little to control prices against the risks of doing too much and unduly damaging the economy.
For the Fed, the big surprise has been the strength of the U.S. economy, which is holding up remarkably well in the face of the most aggressive rate-hike campaign in decades. Consumer spending remains robust and unemployment remains low, even though there have been some recent signs of cooling in the labour market.
The Fed’s new projection includes a significant upward revision to economic growth estimates, with FOMC members now expecting the U.S. economy to grow 2.1 per cent this year, compared with a 1-per-cent estimate in June. It also revised its projection for unemployment down, and now sees the unemployment rate rising to 4.1 per cent next year, from the current rate of 3.8 per cent, compared with an estimate of 4.5 per cent in June.
“It’s a good thing that the economy has been able to hold up under the tightening that we’ve done. It’s a good thing that the labour market is strong. … It just means we’ll have to do more in terms of monetary policy to get back to 2 per cent,” Mr. Powell said, pointing to the Fed’s goal of 2-per-cent inflation.
The new projection suggests the prospects of a soft landing have improved. That’s the idea that inflation could fall back to target without a significant recession or rise in unemployment. But the flipside of a more benign economic growth outlook is that interest rates will likely remain higher for longer.
Markets digested that news on Wednesday, prompting a jump in bond yields and a selloff in the stock market. The S&P 500 index fell after the rate announcement, ending the trading day down 0.94 per cent.
“The Fed sent a hawkish signal with the summary of economic projections, doubling down on the ‘higher-for-longer’ theme,” Toronto-Dominion Bank economists, led by Oscar Munoz, the bank’s chief U.S. macro strategist, wrote in a note to clients.
“Talk is cheap at this point in the cycle and the Fed’s projections are just that – their own projections for the ‘soft landing’ going forward. If the data begins to turn more quickly than expected, the Fed can certainly cut rates earlier and more quickly than expected.”
Consumer-price-index inflation in the U.S. has fallen dramatically over the past year, after hitting a four-decade high of 9.1 per cent in June, 2022. CPI inflation did move up slightly in August, to 3.7 per cent from 3.2 per cent in July, as a result of rising gasoline prices. However, measures of core inflation, which capture underlying price pressures, have been trending downward in recent months.
The trend for core inflation is less positive in Canada. On Tuesday, Statistics Canada reported that the annual CPI inflation rate jumped to 4 per cent in August, from 3.3 per cent in July. More concerning for the Bank of Canada: The average of its two preferred measures of core inflation rose to 4 per cent, from 3.75 per cent the previous month.
The strength of core inflation remains a “significant concern” for the Bank of Canada, according to the summary of the rate-decision deliberations, published Wednesday. And it’s a key reason Canada’s central bank isn’t ruling out further interest-rate hikes.
The bank’s decision to hold its policy rate steady at 5 per cent on Sept. 6 was influenced by a string of data showing economic growth in Canada is stalling, consumers are pulling back on spending, and the labour market has begun to cool.
“Members agreed that data since their last decision had shown more clearly that demand was slowing, and excess demand was diminishing as monetary policy gained traction,” the summary said.
But Canada’s top central bankers were concerned that the decision to hit pause would be “misinterpreted as a sign that policy tightening had ended and that lower interest rates would follow.”
This happened in January, when the bank announced a “conditional pause” to rate increases after hiking eight times in 2022 and early 2023. Bond markets began pricing in interest-rate cuts for later in 2023, and real estate prices started to surge in the spring as homebuyers bet that mortgage rates had peaked. The Bank of Canada eventually came off the sidelines in June and hiked again in July after receiving stronger-than-expected data on consumer spending and the labour market.
This time around, the central bank wanted to be more clear that they could hike again, and that rate cuts remain a long way off.
“They agreed that they did not want to raise expectations of a near-term reduction in interest rates, given that they only considered keeping the policy rate where it is or raising it further,” the summary said.
Mark Rendell