WASHINGTON (AP) — The end of their two-year battle with inflation is in sight. Federal Reserve officials on Wednesday are likely to set the stage for the first rate cut in four years, a significant policy shift that could ultimately lead to lower borrowing costs for U.S. consumers and businesses.
Inflation has fallen steadily in recent months, approaching the Fed’s 2% target. And the labor market has cooled, with the unemployment rate up about half a percentage point this year to 4.1%. Fed officials have said they are trying to strike a balance between the need to keep interest rates high enough to keep inflation under control and keeping them too high for too long and triggering a recession.
Cutting rates – as early as September – could support the Fed achieve a “soft landing” in which high inflation is defeated without an economic downturn. Such an outcome could also affect this year’s presidential election, as Republicans have sought to link Vice President Kamala Harris to the rise in inflation over the past three years. Former President Donald Trump said the Fed should not cut rates before the election.
“While I do not believe we have reached our ultimate goal, I am convinced that we are approaching the point at which a reduction in the federal funds rate is justified,” said Christopher Waller, a member of the Fed’s board of directors, earlier this month.
According to futures markets, traders in the financial markets believe that the central bank will cut its key interest rate at its meeting on September 17 and 18, with a probability of 100 percent. Fed Chairman Jerome Powell therefore does not have to give the markets any further indication on Wednesday about the timing of a cut, economists say.
Instead, Powell will have more opportunities to explain how the Fed thinks about inflation and interest rates in the coming months, particularly in his speech at the Fed’s annual meeting in Jackson Hole, Wyoming, in overdue August. So he is unlikely to give much indication on Wednesday about how quickly the Fed will cut rates once it begins. Economists expect relatively leisurely cuts unless there are signs that the labor market is weakening, which would prompt the Fed to move more quickly.
Still, the Fed could change several parts of the statement it releases after each meeting to lay the groundwork for a rate cut in September.
For example, in the statement released after its June meeting, Fed officials said, “Over the past few months, there has been modest further progress toward (the Fed’s) 2 percent inflation goal.” On Wednesday, the Fed may delete the word “modest” or otherwise modify it to emphasize that further progress has been made on inflation.
The latest piece of good news on the subject of price increases was the government’s announcement on Friday that the annual inflation rate fell to 2.5 percent in July, the Fed’s preferred inflation measure. That’s down from 2.6 percent the previous month and the lowest level since February 2021, when inflation was just beginning to pick up.
An encouraging sign for the Fed is that rental prices – a major driver of overall inflation – are easing noticeably as novel housing has been completed in many major cities.
Rent inflation was a prime example of what economists call “catch-up inflation,” with prices still rising this year due to distortions from the pandemic economy. Many Americans sought more housing or moved out on their own during COVID, driving up the cost of rents and homes.
To account for these price increases, the government’s rent inflation indicators have risen faster than usual well into this year, even as rapid housing construction has slowed the rise in the cost of novel rentals. Other examples of “catch-up” inflation include car insurance, which rose more than 20% earlier this year compared to a year earlier as insurers charged higher prices to account for the pandemic-related rise in novel car prices. But even car insurance costs have started to rise at a slower pace.
Powell has long said the Fed is seeking “greater confidence” that inflation is falling back toward the Fed’s 2% target. Earlier this month – before the latest inflation figures – he said the latest inflation data “adds some confidence” that inflation is cooling.
Powell and other Fed officials also fear that powerful job growth and rapidly rising wages could potentially fuel inflation as some companies are likely to raise prices to offset higher labor costs.
But growth in hiring and wages has slowed in recent months, and Powell acknowledged this month that the labor market was “not a source of broad inflationary pressures on the economy.”
On Wednesday, the government released a quarterly measure of wage growth, which showed that while wages are still growing at a robust pace, they are not growing as quick as they did three months ago, another indication that inflationary pressures have eased.
