Representational image of the seal of the Board of Governors of the United States Federal Reserve System
| Photo Credit: AP

United States Federal Reserve officials will likely make official what’s been clear for many weeks: With inflation sticking at a level above their 2% target, they are downgrading their outlook for interest rate cuts.

In a set of quarterly economic forecasts they will issue after their latest meeting ends, the policymakers are expected to project that they will cut their benchmark rate just once or twice by year’s end, rather than the three times they had envisioned in March.

The Fed’s rate policies typically have a significant impact on the costs of mortgages, auto loans, credit card rates and other forms of consumer and business borrowing. The downgrade in their outlook for rate cuts would mean that such borrowing costs would likely stay higher for longer, a disappointment for potential homebuyers and others.

ALSO READ | Recalcitrant jumbo: Editorial on inflation

Still, the Fed’s quarterly projections of future interest rate cuts are by no means fixed in time. The policymakers frequently revise their plans for rate cuts — or hikes — depending on how economic growth and inflation measures evolve over time.

But if borrowing costs remain high in the coming months, they could also have consequences for the presidential race. Though the unemployment rate is a low 4%, hiring is robust and consumers continue to spend, voters have taken a generally sour view of the economy under President Joe Biden. In large part, that’s because prices remain much higher than they were before the pandemic struck. High borrowing rates impose a further financial burden.

The Fed’s updated economic forecasts, which it will issue Wednesday afternoon, will likely be influenced by the government’s May inflation data being released in the morning. The inflation report is expected to show that consumer prices excluding volatile food and energy costs — so-called core inflation — rose 0.3% from April to May. That would be the same as in the previous month and higher than Fed officials would prefer to see.

ALSO READ | Rationale behind raising interest rates

Overall inflation, held down by falling gas prices, is thought to have edged up just 0.1%. Measured from a year earlier, consumer prices are projected to have risen 3.4% in May, the same as in April.

Inflation had fallen steadily in the second half of last year, raising hopes that the Fed could achieve a “soft landing,” whereby it would manage to conquer inflation through rate hikes without causing a recession. Such an outcome is difficult and rare.

But inflation came in unexpectedly high in the first three months of this year, delaying hoped-for Fed rate cuts and potentially imperiling a soft landing.

In early May, Chair Jerome Powell said the central bank needed more confidence that inflation was returning to its target before it would reduce its benchmark rate. Powell noted that it would likely take more time to gain that confidence than Fed officials had previously thought.

Last month, Christopher Waller, an influential member of the Fed’s Board of Governors, said he needed to see “several more months of good inflation data” before he would consider supporting rate cuts. Though Mr. Waller didn’t spell out what would constitute good data, economists think it would have to be core inflation of 0.2% or less each month.

Mr. Powell and other Fed policymakers have also said that as long as the economy stays healthy, they see no need to cut rates soon.

“Fed officials have clearly signaled that they are in a wait-and-see mode with respect to the timing and magnitude of rate cuts,” Matthew Luzzetti, chief U.S. economist at Deutsche Bank, said in a note to clients.

The Fed’s approach to its rate policies relies heavily on the latest turn in economic data. In the past, the central bank would have put more weight on where it envisioned inflation and economic growth in the coming months.

Yet now, “they don’t have any confidence in their ability to forecast inflation,” said Nathan Sheets, chief global economist at Citi and a former top economist at the Fed.

“No one,” Mr. Sheets said, “has been successful at forecasting inflation” for the past three to four years.

A file photo of the U.S. Federal Reserve
| Photo Credit: Reuters

The U.S. Federal Reserve report released on March 1 flagged a range of what it deemed “notable” vulnerabilities in the financial markets while adding the stress that roiled the banking sector a year ago has faded considerably.

The Fed also used the latest release of its periodic Monetary Policy Report to say that officials will not start moving their short-term interest rate target down until they gain greater confidence inflation is truly moving back to the 2% target.

In the report, the central bank noted several ways in which borrowing levels, or leverage, were increasing risks in the financial sector. It also said stock prices were “close to historical highs.”

The Fed said leverage at hedge funds had stabilized at high levels, while life insurers were facing a situation where they were becoming more reliant on non-traditional sources of funding.

Banking system is sound, says Fed

Meanwhile, while banks’ sources of funding remain liquid and stable, funding costs were on the rise, the central bank said. But even with those rising challenges, the Fed report said “the banking system remains sound and resilient” and “acute stress in the banking system has receded since last spring.”

Listen: What caused the collapse of Silicon Valley Bank, and is there a danger of ‘contagion’? | In Focus podcast

A year ago, the Fed contended with bank problems of a magnitude that forced it to launch a new liquidity facility, amid surging demand for central bank credit. Much of that borrowing has faded away as a major concern for markets and the central bank, and the Fed will close this month the Bank Term Funding Program stood up to deal with the troubles.

The Fed report said credit remains available for most who want it, while acknowledging borrowing’s high expense: “Interest rates on both credit cards and auto loans remain higher than the levels observed in 2018 at the peak of the previous monetary policy tightening cycle.”

Inflation under watch

On the economy, the Fed reiterated it was committed to getting inflation pressures back to its target and said the rate-setting Federal Open Market Committee “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.”

Also read: American consumers are pushing back against high inflation — and they are winning

Fed forecasts from the close of last year, buttressed by officials’ comments, have all pointed to rate cuts this year amid falling inflation pressures. However economic strength and an uneven path back to 2% have pushed back market expectations of when the easing will start, likely toward the summer.

The Fed’s twice-yearly report to Congress comes ahead of two days of testimony by Fed Chair Jerome Powell set for Wednesday and Thursday next week. Mr. Powell is likely to face a barrage of questions from lawmakers about the Fed’s tight policy stance and expectations for easing it, a sensitive topic in a presidential election year.

The report generally recaps economic developments and actions taken by the Fed in the period since the previous update given to lawmakers. Fed concerns over financial markets’ vulnerabilities had already been noted in the release of meeting minutes for the January FOMC meeting, released last week.

At the Fed’s most recent policy meeting in January, central bank staff briefed policymakers on their assessment of stability within the U.S. financial system, with the minutes saying staff “characterized the system’s financial vulnerabilities as notable.”

A number of congressional Democrats have already been hounding Mr. Powell over high rates, complaining they are exacerbating already-poor housing affordability for low- and middle-income households. Republicans, meanwhile, have been critical of the Fed’s initially slow response to inflation and could chastise Mr. Powell over indications he may lower rates ahead of the November election.

Rate cuts ahead of the presidential elections?

The Fed’s next interest rate-setting meeting is scheduled for March 19-20, and policymakers are widely expected to leave their benchmark policy rate unchanged at 5.25%-5.5%, where it has been since July.

The upcoming meeting will also bring updated forecasts on inflation, employment, growth and interest rates. In December, the Fed pencilled in three rate cuts, and in comments to reporters on Wednesday, New York Fed leader John Williams said that outlook is a “reasonable” place for Fed officials to think about the monetary policy outlook.

However, the timing of action remains in question. After a benign run of inflation data through the second half of 2023 led financial markets initially to position for rate cuts as early as the March meeting, the first set of inflation readings for 2024 has at least temporarily stalled some of that momentum on taming the pace of price increases.

Market pricing now reflects a prevailing view that the first cut will occur in June, although a first cut at the April 30-May 1 meeting is not out of the question.

Inflation has changed the way many Americans shop. Now, those changes in consumer habits are helping bring down inflation.

Fed up with prices that remain about 19%, on average, above where they were before the pandemic, consumers are fighting back. In grocery stores, they’re shifting away from name brands to store-brand items, switching to discount stores or simply buying fewer items like snacks or gourmet foods.

More Americans are buying used cars, too, rather than new, forcing some dealers to provide discounts on new cars again.

The growing consumer pushback to what critics condemn as price-gouging has been most evident with food and consumer goods like paper towels and napkins.

In recent months, consumer resistance has led large food companies to respond by sharply slowing their price increases from the peaks of the past three years.

This doesn’t mean grocery prices will fall back to their levels of a few years ago, though with some items, including eggs, apples and milk, prices are below their peaks. However, the milder increases in food prices should help further cool overall inflation, which is down sharply from a peak of 9.1% in 2022 to 3.1%.

Political impact

Public frustration with prices has become a central issue in President Joe Biden’s bid for re-election. Polls show that despite the dramatic decline in inflation, many consumers are unhappy that prices remain so much higher than they were before inflation began accelerating in 2021.

Mr. Biden has echoed the criticism of many left-leaning economists that corporations jacked up their prices more than was needed to cover their own higher costs, allowing themselves to boost their profits. The White House has also attacked “shrinkflation,” whereby a company, rather than raising the price of a product, instead shrinks the amount inside the package. In a video released on Super Bowl Sunday, Mr. Biden denounced shrinkflation as a “rip-off.”

Consumer pushback against high prices suggests to many economists that inflation should further ease. That would make this bout of inflation markedly different from the debilitating price spikes of the 1970s and early 1980s, which took longer to defeat. When high inflation persists, consumers often develop an inflationary psychology: Ever-rising prices lead them to accelerate their purchases before costs rise further, a trend that can itself perpetuate inflation.

“That was the fear — that everybody would tolerate higher prices,” said Gregory Daco, chief economist at EY, who notes that it hasn’t happened. “I don’t think we’ve moved into a high inflation regime.”

Instead, this time many consumers have reacted like Stuart Dryden, a commercial underwriter at a bank who lives in Arlington, Virginia. On a recent trip to his regular grocery store, Mr. Dryden, 37, pointed out big price disparities between Kraft Heinz-branded products and their store-label competitors, which he now favours.

Mr. Dryden, for example, loves cream cheese and bagels. A 12-ounce tub of Kraft’s Philadelphia cream cheese costs $6.69. The store brand, he noted, is just $3.19. A 24-pack of Kraft single cheese slices is $7.69; the store label, $2.99. And a 32-ounce Heinz ketchup bottle is $6.29, while the alternative is just $1.69. Similar gaps existed with mac-and-cheese and shredded cheese products.

“Just those five products together already cost nearly $30,” Dryden said. The alternatives were less than half that, he calculated, at about $13.

“I’ve been trying private-label options, and the quality is the same and it’s almost a no-brainer to switch from the products I used to buy a ton of to just the private label,” he said.

Alex Abraham, a spokesman for Kraft Heinz, said that its costs rose 3% in the final three months of last year but that the company raised its own prices only 1%. “We are doing everything possible to find efficiencies in our factories and other parts of our business to offset and mitigate further price increases,” Mr. Abraham said.

Last week, Kraft Heinz said sales fell in the final three months of last year as more consumers traded down to cheaper brands.

Mr. Dryden has taken other steps to save money: A year ago, he moved into a new apartment after his previous landlord jacked up his rent by about 50%. His former apartment had been next to a relatively pricey grocery store, Whole Foods. Now, he shops at a nearby Amazon Fresh and has started visiting the discount grocer Aldi every couple of weeks.

Corporations exploited disruptions to increase prices

Samuel Rines, an investment strategist at Corbu, says that PepsiCo, Kimberly-Clark, Procter & Gamble and many other consumer food and packaged goods companies exploited the rise in input costs stemming from supply-chain disruptions and Russia’s invasion of Ukraine to dramatically raise their prices — and increase their profits — in 2021 and 2022.

A contributing factor was that millions of Americans enjoyed solid wage gains and received stimulus checks and other government aid, making it easier for them to pay the higher prices.

Still, some decried the phenomenon as “greedflation.” And in a March 2023 research paper, the economist Isabella Weber at the University of Massachusetts, Amherst, referred to it as “seller’s inflation.”

Yet beginning late last year, many of the same companies discovered that the strategy was no longer working. Most consumers have now long since spent the savings they built up during the pandemic.

Lower-income consumers, in particular, are running up credit card debt and falling behind on their payments. Americans overall are spending more cautiously. Mr. Daco notes that overall sales during the holiday shopping season were up just 4% — and most of it reflected higher prices rather than consumers actually buying more things.

As an example, Mr. Rines points to Unilever, which makes, among other items, Hellman’s mayonnaise, Ben & Jerry’s ice cream and Dove soaps. Unilever jacked up its prices 13.3% on average across its brands in 2022. Its sales volume fell 3.6% that year. In response, it raised prices just 2.8% last year; sales rose 1.8%.

“We’re beginning to see the consumer no longer willing to take the higher pricing,” he said. “So companies were beginning to get a little bit more sceptical of their ability to just have price be the driver of their revenues. They had to have those volumes come back, and the consumer wasn’t reacting in a way that they were pleased with.” Unilever itself recently attributed poor sales performance in Europe to “share losses to private labels.”

Other businesses have noticed, too. After their sales fell in the final three months of last year, PepsiCo executives signalled that this year they would rein in price increases and focus more on boosting sales. “In 2024, we see … normalization of the cost, normalization of inflation,” CEO Ramon Laguarta said. “So we see everything trending back to our long-term” pricing trends.

Jeffrey Harmening, CEO of General Mills, which makes Cheerios, Chex Cereal, Progresso soups and dozens of other brands, has acknowledged that his customers are increasingly seeking bargains. McDonald’s executives have said that consumers with incomes below $45,000 are visiting less and spending less when they do visit and say the company plans to highlight its lower-priced items. “Consumers are more wary — and weary — of pricing, and we’re going to continue to be consumer-led in our pricing decisions,” Ian Borden, the company’s chief financial officer, told investors.

Federal Reserve’s take

Officials at the Federal Reserve, the nation’s primary inflation-fighting institution, have cited consumers’ growing reluctance to pay high prices as a key reason why they expect inflation to fall steadily back to their 2% annual target.

“Firms are telling us that price sensitivity is very much higher now,” Mary Daly, president of the Federal Reserve Bank of San Francisco and a member of the Fed’s interest-rate setting committee, said last week. “Consumers don’t want to purchase unless they’re seeing a 10% discount. … This is a serious improvement in the role that consumers play in bridling inflation.”

Surveys by the Fed’s regional banks have found that companies across all industries expect to impose smaller price increases this year. The New York Fed says companies in its region plan to raise prices an average of about 3% this year, down from about 5% in 2023 and as much as 7% to 9% in 2022.

Such trends suggest that companies were well on their way to slowing their price hikes before Mr. Biden’s most recent attacks on price gouging. Claudia Sahm, founder of SAHM Consulting and a former Fed economist, said, “consumers are more powerful than President Biden.”

The U.S. Federal Reserve is widely expected to keep its key short-term interest rate unchanged when it meets next week. File
| Photo Credit: Reuters

An inflation gauge that is closely monitored by the Federal Reserve showed price increases remained elevated in September amid brisk consumer spending and strong economic growth.

Friday’s report from the Commerce Department showed that prices rose 0.4% from August to September, the same as the previous month. And compared with 12 months earlier, inflation was unchanged at 3.4%.

Taken as a whole, the figures the government issued Friday show a still-surprisingly resilient consumer, willing to spend briskly enough to power the economy even in the face of persistent inflation and high interest rates. Spread across the economy, the strength of that spending is itself helping to fuel inflation.

In a cautionary note, consumers relied increasingly on savings to fuel their shopping last month. Income growth slowed. Adjusted for inflation, income actually fell slightly.

Yet spending jumped 0.4%, after adjusting for inflation. The saving rate fell to 3.4%, down from the 6%-plus average before the pandemic.

“That is clearly unsustainable, and we expect spending growth will slow sharply in the quarters ahead,” said Michael Pearce, lead U.S. economist at Oxford Economics, a consulting firm.

September’s month-to-month price increase exceeds a pace consistent with the Fed’s 2% annual inflation target, and it compounds already higher costs for such necessities as rent, food and gas. The Fed is widely expected to keep its key short-term interest rate unchanged when it meets next week. But its policymakers have flagged the risk that stronger growth could keep inflation persistently high and require further rate hikes to quell it.

Since March 2022, the central bank has raised its key rate from near zero to roughly 5.4% in a concerted drive to tame inflation. Annual inflation, as measured by the separate and more widely followed consumer price index, has tumbled from the 9.1% peak it reached in June of last year.

On Thursday, the government reported that strong consumer spending drove the economy to a robust 4.9% annual growth rate in the July-September quarter, the best such showing in nearly two years. Heavy spending by consumers typically leads businesses to charge higher prices. In Friday’s report on inflation, the government also said that consumer spending last month jumped a robust 0.7%.

Spending on services jumped, Friday’s report said, led by greater outlays for international travel, housing and utilities.

Excluding volatile food and energy costs, “core” prices rose 0.3% from August to September, above the 0.1% uptick the previous month. Compared with a year earlier, though, core inflation eased to 3.7%, the slowest rise since May 2021 and down from 3.8% in August.

A key reason why the Fed may keep rates unchanged through year’s end is that September’s 3.7% year-over-year rise in core inflation matches the central bank’s forecast for this quarter.

With core prices already at that level, Fed officials will likely believe they can “proceed carefully,” as Chair Jerome Powell has said they will do, and monitor how the economy evolves in coming months.

Still, the data in Friday’s report showed that while prices for many goods, including cars, furniture and appliances are actually falling, the price increases for services remain chronically high.

Restaurant meals, for example, rose 0.4% in price from August to September, up from a 0.2% rise the previous month. They are now 5.8% more expensive than they were a year earlier.

One measure the Fed is monitoring closely — services prices, excluding energy and housing — jumped 0.4% last month, after rising only 0.1% in August. The Fed watches that gauge because it tracks prices in a set of industries that are labor-intensive and particularly sensitive to rising wages. Higher wages can fuel inflation if businesses pass on their higher labor costs by raising prices.

A solid job market has helped fuel consumer spending, with wages and salaries having outpaced inflation for most of this year. Yet Friday’s report showed that the growth in overall income — a category that, in addition to wages, includes interest income and government payments — has slowed. Adjusted for inflation, after-tax income slipped 0.1% in September, the third straight monthly decline. Shrinking incomes could weaken spending and growth in the months ahead.

Washington:

The US Federal Reserve voted Wednesday to keep interest rates at a 22-year high, while forecasting an additional rate hike before the end of the year to bring down inflation.

The Fed’s decision to keep its key lending rate between 5.25 percent and 5.50 percent gives policymakers time to “assess additional information and its implications for monetary policy,” the central bank said in a statement.

After 11 interest rate hikes since March last year, inflation has fallen sharply but remains stubbornly above the Fed’s long-run target of two percent per year — keeping pressure on officials to consider further policy action.

On Wednesday, the Fed said economic activity had been expanding “at a solid pace,” while noting strong job gains and a low unemployment rate.

A recent string of positive economic data has raised hopes that policymakers can slow price increases without triggering a damaging recession.

Alongside its interest rate decision, the rate-setting Federal Open Market Committee (FOMC) also updated members’ forecasts for a range of economic indicators, as well as expectations of future monetary policy.

FOMC members left the median projection for interest rates between 5.50 percent and 5.75 percent, keeping alive the possibility of another quarter percentage point hike before year-end.

They also lifted expectations for interest rates next year by half a percentage point, suggesting the Fed anticipates rates will have to stay significantly higher for longer in order to lower inflation to target.

FOMC members more than doubled the median projection for economic growth this year as well to 2.1 percent, from 1.0 in June, and sharply raised their forecast for next year.

The prediction for the unemployment rate in 2023 was lowered slightly from June, suggesting the jobs market is faring better than hoped, while the expectation for headline inflation was increased slightly.