Federal Reserve hammers home its message: Rates won’t drop any time soon

Federal Reserve officials are trying to douse any lingering hope that the brightening inflation outlook will give them leeway to cut interest rates later this year.

© Federel Reserve Bank of Boston
Susan M. Collins, president of the Federal Reserve Bank of Boston.

In a series of recent speeches, central bankers have fallen in line behind Fed chair Jerome Powell with a consistent message: the federal funds rate — which influences the cost of mortgages, credit card debt, and business loans — will climb above 5 percent and stay there for some time.

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On Thursday, Susan M. Collins, president of the Federal Reserve Bank of Boston, did her part to amplify the party line.

“While it is promising to see the effects of higher rates starting to spread from the most interest-sensitive sectors to the broader economy, more is required to ensure a steady path toward our inflation target,” Collins said at a Boston Fed conference on the New England economy. “I anticipate the need for further rate increases, likely to just above 5 percent, and then holding rates at that level for some time.”

After getting a late start taking on soaring consumer prices, the Fed has aggressively boosted the benchmark rate, including a run of four unusually steep increases of three-quarters of a percentage point.

After a half-point hike in December, the benchmark rate stands in the range of 4.25 to 4.5 percent, up from near zero last March.

As the inflation picture has improved, Fed officials have said they will take a “slower but higher” approach to determining how high rates need to go to ensure that inflation moves meaningfully back to their 2 percent target. Despite a recent slowing in some key inflation numbers, prices continue to rise at a pace far above that target.

Most investors expect members of the Fed’s rate-setting committee to approve a quarter-point increase at their Jan. 31-Feb. 1 meeting.

The new year opened with some optimism that inflation would retreat enough to allow the Fed to first pause raising rates, and then begin rolling back the increases in the back half of 2023.

The central bank’s preferred inflation measure — the Personal Consumption Expenditures index excluding food and energy — fell to 4.7 percent in November, the latest data available, from a recent peak of 5.4 percent in February.

It’s enough progress, some economists say, that the Fed should now wait to see whether inflation continues to retreat before boosting rates further and putting millions of workers in danger of losing their jobs.

But in the run-up to their next meeting, central bankers have made clear that rate cuts were unlikely any time soon.

On Wednesday, St. Louis Fed president James Bullard said policy makers should quickly push rates to a range of 5.25 percent to 5.5 percent by the end of the year, one of the most aggressive forecasts among Fed officials.

“We want to err on the tighter side to make sure we get the disinflationary process to take hold in the economy and push inflation back to the 2 percent target,” he said at a Wall Street Journal event. Bullard said that a half-point increase would be appropriate at the Fed’s next meeting.

In an interview with the Associated Press on Wednesday, Cleveland Fed leader Loretta Mester also said rates need to move higher, but she didn’t disclose a preference between a quarter-point or half-point next step.

“We’re not above 5 percent, which I think is going to be needed given where my projections are for the economy,” she said. “I just think we need to keep going, and we’ll discuss at the meeting how much to do”

Fed presidents in Atlanta, Dallas, Richmond, and San Francisco have signaled that they back a quarter-point hike.

In her speech, Collins said the sharp rise in interest rates since last year has cooled consumer and business demand. Coupled with an untangling of supply chain constraints and lower energy prices, the cost of some goods is declining. Housing costs are expected to moderate this year, she said.

But services inflation remains persistently high, she said, and the Fed believes the tight job market is a primary cause because wages are the biggest piece of the cost of services.

“While labor market activity has shown some signs of moderating, there is still a long way to go,” Collins said.

Translation: Inflation won’t really be under control until layoffs increase and employers can trim back the wage increases they have used to attract workers.

In December, the Fed forecast that unemployment would hit 4.6 percent this year, up from the current 3.5 percent. An increase of that size would mean about 1.8 million workers losing their jobs, based on the current labor force.

Past experience shows that such a spike would almost certainly trigger a recession, either this year or next.

Collins said on Thursday that she remained hopeful that a “significant economic downturn” could be avoided.

“But I also recognize risks and uncertainties to that outlook, including the possibility of a more substantial downturn driven by a self-fulfilling loss of confidence in the economy,” she said.

Fed officials have said again and again that a healthy economy requires stable prices. As they’ve made clear in recent days with their comments on higher interest rates, they are willing to risk millions of jobs to prove their point.

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