US Federal Reserve poised to shift to quarter-point rate rise as inflation eases

The US Federal Reserve is set to increase interest rates rate by a quarter of a percentage point on Wednesday, marking a return to slower, more orthodox rate rises after it yanked up the cost of borrowing last year.

With inflation seemingly past its peak and economic activity beginning to cool more noticeably, the Fed is expected to raise its benchmark rate to between 4.5 per cent and 4.75 per cent, the highest level since September 2007.

A quarter-point increase would be a break with the unusually large half and three-quarter-point rate rises the Fed relied on in 2022 as it wrestled with soaring inflation.

By contrast, the European Central Bank and the Bank of England are both expected to increase rates by 0.5 points on Thursday.

“The Fed is further into the tightening cycle and other central banks have more work to do [to defeat high inflation],” said Neil Shearing, chief economist of Capital Economics.

Despite a larger than expected fall in eurozone inflation in January, core inflation in the bloc remains high.

Fed officials have said slower tightening will give them more time to assess the impact of last year’s cumulative increase of 4.25 points in the benchmark federal funds rate, as well as greater flexibility to adjust course if necessary.

But the Fed is still expected to signal that more rate rises are needed, despite market scepticism over how many increases it will carry out and when it will start to cut borrowing costs.

With wage growth remaining high and the number of US job vacancies jumping again in December, Fed officials do not yet think the labour market has cooled sufficiently to bring inflation down to the central bank’s 2 per cent target.

Demand for workers was unexpectedly high last month, with employers posting an additional 572,000 job openings on the last day of 2022. That brought the total number of vacancies to 11mn, according to the labour department’s Job Openings and Labor Turnover Survey released Tuesday.

That is up from 10.46mn openings reported in November, above economists’ forecast that openings would decline to 10.25mn, but still below the record high set in March 2022.

The Fed’s statement, which is released alongside the rate announcement at 2pm Eastern Time on Wednesday, will provide further guidance.

Since the central bank started raising rates last March, its statement has consistently noted that the Federal Open Market Committee expects that “ongoing increases in the target range will be appropriate”. Changes to that wording may be taken by Wall Street that the Fed is close to the end of its rates-rising campaign.

Alternatively, the Fed may choose to note that it expects to keep its policy rate at a restrictive level “for some time”, despite hopes in financial markets that interest rates can be cut in the later months of this year.

In December, most officials projected the fed funds rate would peak at between 5 per cent and 5.25 per cent this year and for that level to be maintained throughout 2023.

Fed officials have stuck to that thinking in recent weeks. If the path they set out in December still holds, it suggests the central bank will implement two more quarter-point rate rises beyond Wednesday’s increase.

But policymakers have been unable to convince money managers and traders in fed funds futures markets. Financial markets continue to assume that rates will peak short of 5 per cent and that Fed will subsequently cut them by half a percentage point before the end of the year.

That has set the stage for what Tobias Adrian, the IMF’s head of monetary and capital markets, warned could be a shock if the inflation data disappoints in the future and the Fed tightens further as a result.

Additional reporting by Taylor Nicole Rogers in New York