Fed saw slowing rate hikes, likely to end below 5%

By Ann Saphir

(Reuters) – US central bankers kicked off their last policy-making meeting of the year on Tuesday with data suggesting inflation is finally cooling down, allowing them to delay rate hikes into next year and, traders are now betting, stop below 5% by March.

Federal Reserve policymakers are still raising policy rates by half a percentage point to a range of 4.25%-4.5% on Wednesday, a smaller increase than the 75 basis points per meeting rate they’ve stuck to since June, but still a big increase by historical standards.

But after a Labor Department report showed consumer prices rose at their slowest pace in nearly a year last month, futures contracts tied to the Fed’s policy rate continued to price next year. Traders are now betting on hikes of 25 basis points at each of the Fed’s first two meetings in 2023 and no more, with some chance that the final hike could come in May instead of March.

Either way, that would bring the key rate to 4.75%-5%, lower than some economists expected and markets had guessed given stubbornly high inflation and a stronger-than-expected labor market for much of this year. .

Tuesday’s report showed that the consumer price index rose 0.1% in November from the previous month, up from a 0.4% increase in October. The slowdown suggests the Fed’s most aggressive series of rate hikes in 40 years may finally slow demand and ease price pressures more broadly.

“Overall, this is very good news for the Fed – two consecutive months of data pointing to a weakening of inflation,” said Subadra Rajappa, head of US interest rate strategy at Société Générale.

Still, she said, with financial conditions easing — stocks rose after the report — and an unemployment rate of 3.7%, suggesting a still strong job market, the Fed may need to raise rates slightly higher than markets currently Prices.

And when Fed Chair Jerome Powell offered his thoughts on the policy trajectory at his post-meeting press conference on Wednesday, she said, “I don’t see him pivoting about policy in any meaningful way — I think it’s just too early.”

RATE REDUCTION?

Consumer prices rose 7.1% year on year, the smallest increase since December 2021, Tuesday’s data showed.

The elevation remains much too high for comfort. The Fed targets annual inflation of 2%, as measured by the personal consumption expenditure price index, which is typically one or two percentage points lower than the CPI.

Still, the under-the-hood data in the CPI report seemed to reinforce the case for the Fed to back off from tightening.

Commodity inflation eased, reflecting a reduction in pandemic-induced supply chain disruptions, with the measure excluding food and energy falling 0.5%. Meanwhile, services inflation rose, driven by a 0.7% monthly increase in owners’ equivalent rent – a measure of what homeowners would earn if they rented their property.

Still, Fed policymakers say they are looking at forward-looking trends, such as new rent rates that suggest rental inflation will ease next year. And services inflation excluding shelter was unchanged after falling in October.

After the report, interest rate futures pointed to a drop of about half a percentage point in the Fed’s key rate by the end of 2023, an apparent bet on any chance of a recession as higher borrowing costs deter more firms from expanding and slower sales forces put some in laid off.

Powell, for his part, has said the Fed does not want to cut interest rates anytime soon, but rather keep them high to keep inflation depressed and bring it firmly back on target.

The Fed will release updated policy projections of unemployment, inflation and interest rates for next year and beyond at the end of their meeting on Wednesday.

(Reporting by Ann Saphir; editing by Andrew Heavens and Andrea Ricci)

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