Inflation is close to 2%. So why isn’t the Fed willing to cut interest rates?

Inflation is close to 2%.  So why isn’t the Fed willing to cut interest rates?

WASHINGTON (AP) — From Wall Street traders to auto dealers to homebuyers, Americans are looking forward to the Federal Reserve starting to lower interest rates and ease the heavy burden on borrowers.

The Fed is widely expected to do so this year — and perhaps several times. Inflation, as measured by its preferred measure, It increased in the second half of 2023 at an annual rate of about 2% – The Fed’s target level. However, several central bank officials stressed this week that they are not ready to pull the trigger yet.

Why, with inflation almost beat and interest rates at their highest levels in 22 years, isn’t now a good time to cut rates?

Most Fed policymakers said they are optimistic that even as the economy and labor market continue to grow, inflation pressures will continue to slow. But they also warn that the economy looks so strong that there is a real risk that price increases could accelerate again.

Several officials said they wanted more time to see whether inflation would continue to fall. In the meantime, they note that the economy is strong enough that it can thrive without any interest rate cuts.

“It’s going to get icy, and it’s going to take its time,” said Stephen Blitz, chief U.S. economist at Global Data TS Lombard. “They are willing to say: ‘We don’t know, but we can wait, so we will wait.’” “

The health of the economy has also raised questions about the effectiveness of the Fed’s 11 interest rate hikes. If higher interest rates on borrowing barely constrain the economy, some officials may conclude that higher interest rates should remain in place longer or that too few interest rate cuts are needed.

On the other hand, the continued resilience of the economy gives them the luxury to take a cautious approach. Last month, for example, America’s employers introduced a hiring spree to start 2024, Adding 353 thousand jobs In January. The unemployment rate remained at 3.7%, slightly above its lowest level in half a century.

“I don’t feel like there’s a sense of urgency here,” Loretta Mester, president of the Cleveland Fed, told reporters on Tuesday. Meester is among 12 Fed officials voting on interest rate policy this year. “I think later this year, if things develop as expected, we will be able to start lowering the interest rate.”

However, their caution carries risks. Now, the economy shows up On the right track to a “soft landing.”“, through which inflation will be defeated without causing a recession or higher unemployment rates. But the longer borrowing rates remain high, the greater the risk that many businesses and consumers will stop borrowing and spending, weakening the economy and potentially pushing it into recession.

Higher interest rates could also exacerbate the distress of banks saddled with bad commercial real estate loans, which will be difficult to refinance at higher interest rates.

The high cost of borrowing has become a headache for David Kelleher’s Chrysler Jeep dealership outside Philadelphia. Kelleher recalls that just two and a half years ago, his clients could get a car loan at less than 3% interest. Now, they are lucky to get 5.5%.

Customers who had monthly car lease payments of $399 three years ago are finding that with vehicle prices now higher and interest rates higher, their monthly payments on a new car will be closer to $650. This trend is pushing many of his customers toward lower-priced used cars — or not buying at all.

“We need the government to address interest rates… and understand that it has achieved its goal of lowering inflation,” Kelleher said. “If interest rates can be lowered, I think we will start selling more cars.”

Kelleher is likely to get his wish by May or June, when most economists expect the Fed to begin cutting its benchmark interest rate, which is now about 5.4%. In December, all but two of the 19 policymakers who participated in the Fed’s policy discussions said they expected the central bank to cut interest rates this year. (Twelve of these nineteen are entitled to vote on rate policies each year.)

However, economic growth has, by some measures, accelerated since then. In the last three months of last year, the economy Expanded at an unexpectedly strong annual rate of 3.3%. Surveys of manufacturers and service providers, such as retailers, banks and shipping companies, also reported that business picked up last month.

Overall, the latest reports indicate that the economy may not be headed toward a soft landing, but rather toward what some economists call “no landing.” By this they mean a scenario in which the economy remains strong and inflation is a continuing threat, potentially remaining above the Fed’s target. Under this scenario, the Fed would feel compelled to keep interest rates at high levels for an extended period.

Powell said last week that while the Fed wants to see “strong growth” continue, a strong economy threatens to lift inflation.

“I think that’s a risk…that inflation will accelerate,” Powell said. “I think the biggest risk is that it settles at a level well above 2%. … That’s why we’re keeping our options open here and why we’re not rushing.”

Other officials explained this week that the Fed is trying to balance the risks of cutting interest rates too early — which could cause inflation to accelerate — and keeping interest rates too high for too long, which could lead to a recession.

“At some point, continued deceleration in inflation and labor markets may make it appropriate to lower interest rates,” Andrea Kugler, the recently appointed Fed governor, said Wednesday in her first public address. “On the other hand, if progress in combating inflation stalls, it may be appropriate to keep the target range fixed at its current level for a longer period.”

Some analysts have pointed to signs that the economy is becoming more productive or efficient, allowing it to grow faster without necessarily increasing inflation. However, productivity data is difficult to measure, and any meaningful improvement will not necessarily become apparent for years.

However, Eric Swanson, an economist at the University of California, Irvine, said, “Maybe the economy can afford higher interest rates than we thought in 2019 before the pandemic.”

If so, this may not only delay the Fed’s rate cuts, but may result in fewer of them. Fed officials still say they plan to cut interest rates perhaps three times this year, less than the five or six that some market analysts expect.

(tags for translation) Government Regulations

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