- Inflation cooled last month, increasing the odds that the Federal Reserve will hold the main interest rate on Wednesday at a range between 5% to 5.25% rather than press on with its most aggressive policy tightening in four decades.
- The consumer price index slowed in May to a 4% annual rate compared with 4.9% in April, the Labor Department said Tuesday. The core CPI, which excludes volatile food and energy prices, eased to 5.3% during the same period compared with 5.5% in April.
- Prices for housing, used vehicles and food rose last month more than other categories, sustaining inflation well above the Fed’s 2% target despite 10 straight rate increases from March 2022 to May. Energy and new vehicle prices last month fell 3.6% and 0.1%, respectively.
Fed Chair Jerome Powell and Fed Governor Philip Jefferson, the nominee to serve as vice chair, have voiced openness in recent weeks to pausing after 14 months of rate increases that have pushed borrowing costs to the highest level in 16 years.
The central bank on Wednesday will conclude a two-day meeting with a statement and forecasts for the economy and monetary policy.
Traders in interest-rate futures predict the Fed will suspend monetary tightening. On Tuesday they set 94% odds that policymakers will forgo a rate hike Wednesday, and a 61% probability that they will increase the federal funds rate to a range between 5.25% to 5.5% after a two-day meeting on July 26, according to the CME FedWatch Tool.
Although indicating a pause in tightening this week, Fed “leadership seems quite willing to signal additional hikes down the road,” Goldman Sachs Chief Economist Jan Hatzius said in a note.
Policymakers will probably increase the main interest rate next month by a quarter percentage point and then pause for a year before beginning “very gradual cuts,” Hatzius said. “We continue to think that the rates market is underpricing the outlook for the funds rate over the next one to two years.”
Analysts with the BlackRock Investment Institute agree.
“Policy rates may stay higher for longer than the market is expecting,” they said in a report on Monday, predicting that price pressures will discourage the Fed and other central banks from reducing borrowing costs in 2023.
“Persistent inflation makes it unlikely developed market central banks will cut interest rates this year,” they said.
Central bankers face “a sharp trade-off between living with some inflation and crushing activity” in the economy, the analysts said. They forecast that Fed policymakers will stop raising rates before inflation is on track toward failing to their 2% target.
The Fed has better than even odds of reducing price pressures without triggering a downturn, Powell said last month, noting the strength of the labor market. “The case of avoiding a recession is, in my view, more likely than of having a recession,” he said.