Inflation remains Fed’s key focus
3 min read 23 Mar 2023, 09:41 PM ISTConsumer price inflation in the US came in at 6% year-on-year in February, moderately lower than January, but much higher than the central bank’s 2% target.
PremiumIn yet another attempt to tame inflation, the US Federal Reserve has delivered a 25-basis-point interest rate hike, taking the Fed funds rate to 4.75-5%. One basis point is 0.01%.
Consumer price inflation in the US came in at 6% year-on-year in February, moderately lower than January, but much higher than the central bank’s 2% target. More importantly, the turmoil in the US banking sector has shaken global equity markets as fears of a contagion risk loom.
In its monetary policy statement, Fed Chairman Jerome Powell did acknowledge that recent events in the US banks are likely to lead to tighter credit conditions for households and businesses. Nonetheless, the Fed did not deviate from its fight against inflation and chose to raise rates. This move underscores that inflation remains the most important priority for the US central bank.
In the current mix of US macro with elevated inflation, tight labour market and fairly strong economic indicators, this rate hike does not come as a big surprise. But the Fed’s firm inflation focus is not new. It has been an anchor for monetary policy decisions even in the past and sometimes at the cost of near-term economic growth.
Across various high inflation episodes in the US, like the late 1970s and early 1980s, and more particularly, since the adoption of explicit inflation targeting in 2012, the Fed has always focussed on taming inflation even if short-term growth needs to be compromised. In this pursuit, the Fed raised rate to a historic high of 20% in 1980, leading to a sharp contraction in US’s gross domestic product growth in two consecutive quarters that year.
Even now, the underlying theme that Powell reiterated in his press conference was that without price stability, it’s not possible to achieve sustained and inclusive labour market growth. With the Fed’s dual mandate of price stability and maximum employment, high inflation poses risk to both, and the failure to achieve the former may vitiate efforts to achieve the latter.
And just not the Fed, entrenched inflationary pressures across the globe warranted that most central banks continue to adhere to tightening rates, at least for now.
For instance, the European Central Bank raised benchmark rates for the sixth consecutive time in March. In the case of the Reserve Bank of India, the choices appear to be limited. Retail inflation in India is still above 6%, core inflation is sticky and globally rates are moving higher. So, another rate hike in the RBI’s April policy meeting cannot be ruled out.
Coming back to the Fed, a shift towards a softer policy tone has meant that the clamour for a pause is getting louder. A hint towards policy normalization comes from the change in language in the latest monetary policy press release. The Fed no longer mentioned that “ongoing increases in the target range will be appropriate", which has been in every policy statement since March 2022, when Fed embarked on a rate-hiking cycle. This time instead, the language changed to “some additional policy firming may be appropriate".
What this suggests is that the policy pivot—in the form of a pause—is on the cards if inflation heads southward and economic growth starts to weaken. That said, it would be too early to expect rate cuts starting this year, unless bank-related risks broaden or the US economy slips into a deep recession.
Monetary easing looks likely going into 2024, but interestingly, the median forecasts now peg 2024 Fed funds rate at 4.3%, up from 4.1% in December, suggesting that the magnitude of expected rate cuts next year could be lower than previously envisaged.
