Federal Reserve officials expect to start raising interest rates in 2023, earlier than previously forecast, according to new economic projections that predicted faster growth and sharply higher inflation this year.
At the end of its two-day policy meeting on Wednesday, the US central bank kept its main interest rate on hold at the rock-bottom range of 0 to 0.25 per cent, where it has been since the start of the pandemic.
But whereas in March, when most Fed officials predicted that current rates would be maintained until at least 2024, the consensus has shifted towards an earlier lift-off in 2023, signalling the central bank’s belief in a faster transition to a full recovery and tighter monetary policy.
The median of Fed officials’ estimates now forecasts gross domestic product growth of 7 per cent this year, compared to 6.5 per cent in March, with the unemployment rate dropping to 4.5 per cent, in line with earlier predictions. Core inflation is expected to be 3 per cent this year, sharply higher than the 2.2 per cent expected in March, before falling back to 2.1 per cent in 2022.
“Progress on vaccinations has reduced the spread of Covid-19 in the United States,” the Federal Open Market Committee said. “Amid this progress and strong policy support, indicators of economic activity and employment have strengthened. The sectors most adversely affected by the pandemic remain weak but have shown improvement.”
The FOMC on Wednesday kept its asset purchases steady at $120bn per month — another feature of the exceptionally loose monetary policy introduced to fight the economic fallout from the pandemic. Officials are expected to have held initial talks on the timing and conditions of an eventual move to start reducing those bond buys, but the statement made no mention of a shift.
The process of reducing the Fed’s debt purchases, known as “tapering”, could be discussed for months before a move is made. The Fed has said the economy would have to make “substantial further progress” compared to last December in order for to start scaling back its extraordinary support for the economy.
While inflation has been moving above the Fed’s target of 2 per cent on average, its full employment goal has not been met. Some 7.6m fewer Americans hold jobs than in February 2020.
The Fed has stressed that its monetary policy guidance is not calendar-based but dependent on economic outcomes. Specifically, it said it would only raise interest rates if the economy is at full employment with inflation at 2 per cent and on track to exceed that level for some time. Nevertheless, while seven out of 18 FOMC members predicted in March a first interest rate increase in 2023, 13 did so on Wednesday.
Since the last meeting of the FOMC in April, US equity markets have rallied, while borrowing costs have dropped from recent highs, as investors wagered that the Fed will keep its monetary stimulus going and this year’s inflationary pressures will be transitory.