The Federal Reserve is widely expected to maintain interest rates at its upcoming two-day policy meeting on July 30-31, but may pave the way for potential rate cuts as early as September by acknowledging that inflation has edged closer to the US central bank’s 2% target.
Policymakers has been encouraged by recent data showing that price pressures are easing broadly, with headline inflation moving closer to the Fed’s target and evidence from job, housing, and other markets suggesting that this trend is likely to continue.
“The Fed is only 50 basis points from the target… so it seems that is not very far,” said Jim Bullard, former president of the St. Louis Fed and current dean of Purdue University’s Mitchell E. Daniels Jr. School of Business. “Is it still elevated? Sure. But it is not as elevated as it was.”
The Fed’s preferred inflation measure, the personal consumption expenditures price index, rose 2.5% in June, nearing the target.
This followed a 2.6% gain in May and marks a significant slowdown from the 7.1% annual increase seen in 2022.
A companion measure that strips out volatile food and energy prices was trending at 2.3% over the same period, within sight of the 2% goal.
This data may be enough for Fed officials to change their description of inflation as “elevated” in next week’s policy statement and note rising confidence that the pace of price increases will return to 2%.
Policymakers have indicated that they should start cutting interest rates before inflation fully returns to their target, and if upcoming data stays in line with recent months, they may be running out of time.
A slight change in the statement, perhaps describing inflation as “moderately elevated,” would “send a major signal to markets that you are taking on board all that disinflation that has occurred over the last year and you think it is for real and you don’t think it is going to turn around,” Bullard said.
The Fed lifted its benchmark interest rate to slow the economy after inflation surged and has held it steady in the current 5.25%-to-5.50% range since last July, making the current run of tight monetary policy among the longest in recent decades.
Despite warnings last year that such strict financial conditions could trigger a recession, the Fed appears to have hit a sweet spot.
Inflation has fallen, and while the unemployment rate has risen gradually, it remains at 4.1%, around what many Fed officials see as representing full employment.
Some data, including disappointing recent home sales and rising loan delinquencies, may point to weakness, but the most recent report on overall economic output was surprisingly strong, with growth at a 2.8% annualised rate in the second quarter.
The Fed regards the economy’s underlying potential growth, consistent with stable inflation, at about 1.8%.
“They have had encouraging inflation data… Clearly the economy is slowing. The balance of risks is different than it was four months ago.
Full stop,” said Nathan Sheets, global chief economist at Citi. “It feels like they want to be a little more certain, so signal in July and cut in September.”
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