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Fed Officials Fretted That Markets Would Misread Rate Slowdown

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Federal Reserve officials apprehensive that inflation could remain uncomfortably fast, minutes from their December meeting showed, and a few policymakers fretted that financial markets might incorrectly interpret their decision to lift rates of interest more slowly as an indication that they were giving up the fight against America’s rapid price gains.

Inflation is starting to decelerate but stays abnormally quick: The Personal Consumption Expenditures price index climbed by 5.5 percent within the 12 months through November, down from a 7 percent peak in June 2022 but still nearly triple the Fed’s 2 percent inflation goal. Fed officials still saw inflation as unacceptably high, as of their meeting last month — and apprehensive that rapid price gains might need endurance.

“The risks to the inflation outlook remained tilted to the upside,” Fed officials warned during their December policy meeting, minutes released on Wednesday showed. “Participants cited the chance that price pressures could prove to be more persistent than anticipated, resulting from, for instance, the labor market staying tight for longer than anticipated.”

Such risks arrange a difficult 12 months for Fed policymakers, who will need to make a decision how way more they need to lift rates of interest — and the way long they should hold them at elevated levels — to bring inflation firmly under control. The Fed desires to avoid pulling back too early, which could allow inflation to turn out to be entrenched within the economy. But officials are also conscious that top rates come at a value: As they slow growth and weaken the labor market, employees are prone to earn less and should even lose their jobs.

That’s why the Fed desires to tread fastidiously, bringing price increases under control without inflicting more damage than obligatory. Officials slowed their rate increases last month, lifting their most important policy rate by half a degree after several three-quarter-point moves in 2022. Officials forecast that they might raise rates by more in 2023, but their estimates suggested that they were nearing the extent at which they could pause: They saw rates climbing to about 5.1 percent in 2023, up from about 4.4 percent now.

Inflation F.A.Q.

Card 1 of 5

What’s inflation? Inflation is a loss of buying power over time, meaning your dollar is not going to go as far tomorrow because it did today. It is usually expressed because the annual change in prices for on a regular basis goods and services equivalent to food, furniture, apparel, transportation and toys.

What causes inflation? It could actually be the results of rising consumer demand. But inflation may rise and fall based on developments which have little to do with economic conditions, equivalent to limited oil production and provide chain problems.

Is inflation bad? It depends upon the circumstances. Fast price increases spell trouble, but moderate price gains can result in higher wages and job growth.

Can inflation affect the stock market? Rapid inflation typically spells trouble for stocks. Financial assets typically have historically fared badly during inflation booms, while tangible assets like houses have held their value higher.

“Participants concurred that the committee had made significant progress over the past 12 months in moving toward a sufficiently restrictive stance of monetary policy,” the Fed’s minutes said, referring to the rate-setting Federal Open Market Committee. But more rate moves were judged to be needed, and no officials expected to chop rates in 2023.

“Participants generally observed that a restrictive policy stance would should be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2 percent, which was prone to take a while,” the minutes said.

Officials emphasized the importance of retaining “flexibility and optionality” — Fed-speak for wiggle room to alter their stance abruptly in a world of many uncertainties.

But policymakers apprehensive that markets might misinterpret their decision to slow the pace of rate moves, seeing it as an indication of a “weakening of the committee’s resolve to realize its price-stability goal,” or a judgment that inflation was already making enough progress in slowing down. Policy works through financial markets, and if market-based rates dip or stock prices soar, that could make it cheaper and easier to borrow.

“An unwarranted easing in financial conditions, especially if driven by a misperception by the general public of the committee’s response function, would complicate the committee’s effort to revive price stability,” the minutes said.

Fed interest-rate increases slow the economy by making it dearer to borrow to purchase a house or expand a business. But their impact will not be immediate: It takes time for firms to allocate lower budgets for hiring, as an example, which might then snowball into less power for job applicants, slower wage growth and weaker consumption.

That delayed response is why central bankers want to provide their policy changes time to play out. Officials need to avoid raising rates higher than obligatory, especially at a time when inflation is already slowing down as supply chains heal and fuel becomes cheaper.

But Fed policymakers also think inflation has moved right into a recent phase, one where it’ll not simply fade by itself as supply problems clear up. Wages are increasing rapidly enough that firms are prone to proceed raising their prices to cover climbing labor bills, they think, making it hard for inflation to return fully to normal.

By slowing economic demand, officials try to counteract that, slowing the labor market, bringing pay gains back to more normal levels and allowing inflation to calm down on a sustainable basis.

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