FED STRIKES CAUTIOUS TONE ON INTEREST RATES

The U.S. Federal Reserve’s Open Market Committee agreed on the need to keep raising interest rates to combat inflation but also hinted at a more cautious approach to future hikes, minutes of the group’s last meeting showed.

The Fed has raised rates three times in its last three meetings, by a quarter-point in March, a half-point in May, and three-quarters of a point in late July in the fastest pace of increases since the early 1980s.

The benchmark federal funds rate now ranges between 2.25 and 2.50 percent, a level last seen in 2019.

If inflation keeps spreading across the economy, the committee will need to continue to raise rates aggressively, members indicated.

However, for the first time, the group discussed the risk of raising interest rates more than needed to tame inflation, which could weaken the economy or spark a recession.

“Participants judged that, as the stance of tightening monetary policy further, it likely would become appropriate at some point to slow the pace of policy rate increases while assessing the effects of cumulative policy adjustments on economic activity and inflation,” the minutes said.

The minutes indicate that bank officials are leery of being guided largely or solely by inflation data, which is backward-looking, and now favor looking ahead at what a particular rate increase might do to economic activity in the months ahead, BlackRock portfolio manager Robert Miller told The Wall Street Journal.

Several bank officials have publicly indicated recently that they would favor another half-point bump when the committee meets again next month.

TRENDPOST: The chasm between U.S. interest rates and the rate of inflation will not be spanned by half-point or three-quarter-point interest bumps every two months.

For an interest rate to have a meaningful impact on inflation, it needs to equal or exceed inflation when compounded.

The most recent example is Mexico, as we reported in “Mexico’s Central Bank Sets Record-High Interest Rate” (16 Aug 2022).

When inflation climbed to 8.15 percent in July, the country’s central bank tacked another three-quarters of a point onto its key interest rate, pulling it up to 8.5 percent.

The higher rate guarantees that investments denominated in pesos will make an actual profit over and above inflation.

In contrast, the U.S. and the European Union have set interest rates far below inflation’s pace, guaranteeing that investments denominated in those national and regional currencies will lose money.

In practical terms, they offer negative interest rates.

As the Bank for International Settlement noted in a June public statement, “Gradually raising policy rates at a pace that falls short of inflation increases means falling real interest rates. This is hard to reconcile with the need to keep inflation risks in check. Given the extent of the inflationary pressure unleashed over the past year, real policy rates will need to increase significantly in order to moderate demand.”

TREND FORECAST: The Fed waited far too long to begin to raise interest rates; for far too long, it prioritized healing the labor market after the COVID War instead of tackling inflation as it began to accelerate.

As a result, it is likely to take at least through 2024 for inflation to settle at the Fed’s targeted annual rate of 2 percent.