Federal Reserve officials expect to start raising interest rates earlier than previously forecast in 2023, according to new economic projections that predicted faster growth and sharply higher inflation this year.
At the conclusion of its two-day policy meeting on Wednesday, the US central bank held its key interest rate at the low of 0 to 0.25 percent, where it has been since the start of the pandemic.
But while in March, when most Fed officials predicted current interest rates would be maintained until at least 2024, the consensus has shifted to an earlier launch in 2023, indicating the central bank believes in a faster transition to a full recovery. and tighter monetary policy. The Fed forecasts that at least two rate hikes are expected in 2023.
The median of Fed officials’ estimates now forecast gross domestic product growth of 7 percent this year, compared to 6.5 percent in March, with the unemployment rate dropping to 4.5 percent, in line with earlier forecasts. Core inflation is expected to be 3 percent this year, well above the 2.2 percent forecast in March, before falling to 2.1 percent in 2022.
“Progress in vaccinations has reduced the spread of Covid-19 in the United States,” the Federal Open Market Committee said. “Amid this progress and strong policy support, indicators of economic activity and employment have strengthened. The sectors hardest hit by the pandemic remain weak but have shown improvement.”
The FOMC held its asset purchases steady at $120 billion a month on Wednesday — another hallmark of the exceptionally accommodative monetary policy enacted to combat the economic fallout from the pandemic. Officials are expected to have initial talks about the timing and terms of any move to reduce those bond purchases, but the statement made no mention of a shift.
The process of reducing the Fed’s debt purchases, known as “tapering,” can be discussed for months before a move is made. The Fed has said the economy would need to make “significant further progress” compared to December last year to reduce its extraordinary support to the economy.
Although inflation is above the Fed’s target of 2 percent on average, the target of full employment has not been met. About 7.6 million Americans have fewer jobs than in February 2020.
The Fed has emphasized that its monetary policy guidance is not calendar-based, but dependent on economic results. Specifically, it said it would raise interest rates only when the economy is fully operating at 2 percent inflation and on track to exceed that level for some time. Nevertheless, while seven of the 18 FOMC members predicted a first rate hike in 2023 in March, 13 did so on Wednesday.
Since the last FOMC meeting in April, US stock markets have risen, while borrowing costs have fallen from recent highs, as investors bet the Fed will continue its monetary stimulus and inflationary pressures will be transient this year.
US Treasuries sold strongly following the Fed’s announcement, with five-year Treasury yields rising 0.07 percentage points to about 0.85 percent.
The more policy-sensitive two-year bond was 0.02 percentage point higher at 0.18 percent, while the 10-year benchmark rose more than 0.04 percentage point to 1.54 percent. That’s lower than the recent March highs, but higher than earlier in the week. Yields rise when prices fall.
The Fed also announced Wednesday that it would adjust two technical rates, including the interest it pays banks on excess reserves they hold with the central bank. It raised the so-called IOER rate from 0.10 percent to 0.15 percent. It also agreed to pay more than zero for the reverse buyback program, raising the rate to 0.05 percent.
Money market funds and banks that are eligible to deposit money with the Fed overnight because they have few viable, positive-yielding places to invest the vast amounts of cash their coffers have had since the beginning of the year strengthens. The Fed said in a statement that the adjustments were intended to support “the smooth functioning of short-term funding markets.”