Federal Reserve Keeps Rates Unchanged, Anticipates Two Modest Hikes By Year's End

The Federal Reserve opted to maintain the current interest rates on Wednesday but indicated through new economic projections that borrowing costs are likely to increase by another 0.5 per cent by the end of this year. This decision by the US central bank was driven by an unexpectedly robust economy and a slower decline in inflation. 

To strike a balance between the risks to the economy and the ongoing battle to control inflation, the rate-setting Federal Open Market Committee (FOMC) issued a unanimous policy statement at the conclusion of its recent two-day meeting, stating that “holding the target (interest rate) range steady at this meeting allows the committee to assess additional information and its implications for monetary policy.” 

The statement further emphasised that any future rate hikes would take into account the cumulative tightening of monetary policy, the time lag in which monetary policy affects economic activity and inflation, as well as economic and financial developments. 

The latest projections, signalling a more assertive position than the interest rate decision made on Wednesday, reveal that the median policymakers expect the benchmark overnight interest rate to climb from the current range of 5.00 per cent-5.25 per cent to a range of 5.50 per cent-5.75 per cent by the year's end. Half of the 18 Fed officials projected their "dot" at this level, with three officials even foreseeing the policy rate surpassing six per cent. 

Two officials anticipate the rates to remain unchanged, while four officials view a single additional quarter-percentage-point increase as the most likely scenario. 

Looking ahead to 2024, policymakers foresee a 100-basis point reduction in interest rates, accompanied by a significant decline in inflation. 

Considering the rate outlook and projections, investors are likely to anticipate a resumption of quarter-percentage-point rate hikes starting from the next policy meeting in July. 

The higher rate outlook aligns with an improved outlook for the economy, resulting in a slower pace of progress towards achieving the central bank's two per cent inflation target. 

The median Fed officials revised their economic growth projection for 2023, more than doubling it from 0.4 per cent in the March projections to one per cent. Additionally, they now anticipate the unemployment rate to only rise to 4.1 per cent by the end of the year, compared to the 4.5 per cent projected in March. As of May, the jobless rate stood at 3.7 per cent. 

Due to the stronger-than-expected economy, inflation is expected to decline at a slower rate, with the core Personal Consumption Expenditures Price Index projected to decrease from the current 4.7 per cent to 3.9 per cent by the end of the year. In contrast, the March projections by policymakers anticipated a year-end rate of 3.6 per cent. 

This decision marks a break in a sequence of ten consecutive rate hikes implemented by the Fed in response to the most significant inflation outbreak in four decades. These aggressive policy measures included four substantial increases of 0.75 per cent each during the previous year. 

Since the initiation of the tightening cycle in March 2022, the central bank's policy rate, which influences borrowing costs for households and businesses throughout the economy, has increased by a cumulative five percentage points, reaching its highest level since the period just before the onset of the 2007-2009 recession.