Federal Reserve officials were wary that inflation would slow further unless the US economy and labor markets also cool down, according to minutes from their July policy meeting released on Wednesday.
That means a rate hike in September remains in the cards, given the robust economic activity of this summer. It’s also clear that the decision won’t come without a heated debate since “a couple” officials favored not hiking last month, according to the minutes, illustrating the divide among officials.
“Participants continued to view a period of below-trend growth in real GDP and some softening in labor market conditions as needed to bring aggregate supply and demand into better balance and reduce inflation pressures sufficiently to return inflation to 2 percent over time,” the minutes said.
Fed officials unanimously voted to hike interest rates to a range of 5.25-5.5% in July, the highest level in 22 years, over concerns about inflation not yet being on a solid enough track toward the central bank’s 2% target.
Further rate hikes may still be needed
The minutes showed officials “noted the recent reduction in total and core inflation rates,” but that “they stressed that inflation remained unacceptably high and that further evidence would be required for them to be confident that inflation was clearly on a path toward the Committee’s 2 percent objective.”
Fed officials have a tradition of reaching unanimous decisions, but the Fed’s inflation fight has reached a pivotal point in which the decisions aren’t as obvious, meaning some officials could dissent at next month’s policy meeting. There have only been two meetings in which Fed officials dissented with a decision since the central bank began lifting rates in March 2022. Some argue that frequent dissents could erode confidence in the Fed’s decisions.
Indeed, while some officials think the Fed can afford to hold rates steady, others disagree.
“Inflation is still significantly above” the Fed’s 2% target, Fed Governor Michelle Bowman said earlier this month. “Given these developments, I supported raising the federal funds rate at our July meeting, and I expect that additional increases will likely be needed to lower inflation to the FOMC’s goal.”
Inflationary pressures are continuing to cool, which helps make a case to hold rates steady in September. The Consumer Price Index, a closely watched inflation gauge, rose 3.2% in July from a year earlier, up from June’s 3% annual rise and the first time the CPI picked up in more than a year. But the report also showed that underlying price pressures, such as core inflation, continued to decelerate.
That has emboldened so-called “dovish” officials who favor a less aggressive monetary policy to fight inflation seeking to spare the economy and the job market from unnecessary damage.
“I believe we may be at the point where we can be patient and hold rates steady,” Philadelphia Fed President Patrick Harker said this month.
For a rate pause to remain likely, core inflation must continue to decelerate. That might be difficult if the labor market doesn’t continue to cool or if the economy picks up steam.
“Both doves and hawks acknowledge that inflation remains too high, but for the most part the hawks advocate another rate hike is warranted, serving as insurance to keep inflation expectations anchored,” wrote Quincy Krosby, chief global strategist at LPL Financial, in an analyst note. “The doves are comfortable with a pause that would allow the cumulative effects of rate hikes unwind into the broader economy.”
The Atlanta Fed’s GDPNow real-time tracker estimates the economy will grow an annualized 5.8% rate in the third quarter, more than double the pace the Commerce Department first projected for the second quarter. According to the minutes, such rapid growth would make the Fed uncomfortable and could keep some upward pressure on prices.
Some evidence of easing inflation
Other signs also point to price increases slowing down.
Research from Federal Reserve Bank of San Francisco argues that shelter inflation is poised to fall significantly, reaching 0% in 2024 then turning negative by the second half of the year. Shelter costs made up 90% of inflation in July. Economists have also argued that the full effects of the Fed’s most aggressive rate-hiking campaign in decades haven’t trickled through to the broader, real economy just yet – a point also reflected in the minutes from the Fed’s July meeting.
The surprising economic strength this summer raised optimism among investors and Fed officials that the US economy can avoid a recession or a sharp uptick in unemployment as inflation continues to slow. Such a scenario would be known as a “soft landing.” It’s unclear whether inflation will continue to cool without a sharp deterioration in the labor market and some factors might weigh on the economy in the future, such as the resumption of student loan payments in October and growing consumer debt.
Fed economists are in fact no longer projecting a recession, according to the minutes, which Fed Chair Jerome Powell divulged in his post-meeting news conference last month.
