Further Tightening in Monetary Policy

• According to the minutes from the January 31/February 1 FOMC meeting, participants continued to focus on upside risks to inflation and the associated costs.
• Given that, PNC expects 25 basis point increases in the fed funds rate at each of the next two FOMC meetings.
• FOMC participants noted slowing but still-elevated inflation, slower economic growth, and a tight labor market.
• Although the decision to raise the fed funds rate by 25 bps was unanimous, some participants favored a 50 bps increase.

According to the minutes from the January 31/February 1 Federal Open Market Committee, participants were heartened by the recent slowing in inflation, but remained very concerned about the potential for persistently high inflation. “With inflation remaining unacceptably high, participants expected that a period of below-trend growth in real GDP would be needed to bring aggregate demand into better balance with aggregate supply and thereby reduce inflationary pressures. Some participants judged that recent economic data signaled a somewhat higher chance of continued subdued economic growth, with inflation falling over time to the Committee’s longer-run goal of 2%, although some participants noted that the probability of the economy entering a recession in 2023 remained elevated.

Given this, and the potential that high inflation could become embedded in the economy, participants favored continuing to raise the fed funds rate in the near term in an effort to slow growth and cool off the labor market, albeit with a slower pace of rate hikes than in 2022. “With inflation still well above the Committee’s longer-run goal, participants generally noted that upside risks to the inflation outlook remained a key factor shaping the policy outlook, and that maintaining a restrictive policy stance until inflation is clearly on a path toward 2% is appropriate from a risk-management perspective. A number of participants observed that a policy stance that proved to be insufficiently restrictive could halt recent progress in moderating inflationary pressures, leading inflation to remain above the Committee’s 2% objective for a longer period.” But at the same time, “almost all participants observed that slowing the pace of rate increases at the current juncture would allow for appropriate risk management as the Committee assessed the extent of further tightening needed to meet the Committee’s goals.”

Given continued high inflation, the very strong January jobs report, recent speeches by Fed officials, and now the FOMC minutes, PNC has updated its fed funds rate forecast to include an additional rate hike. PNC now expects the FOMC to raise the fed funds rate by 25 basis points at its next meeting, in mid-March, and then raise it by a further 25 bps at the subsequent meeting, in early May; the previous forecast did not include a May rate hike. PNC then expects the FOMC to keep the fed funds rate in a range between 5.00% and 5.25% through the rest of 2023 and into 2024. PNC then expects fed funds rate cuts starting in early 2024 as inflation slows due to an expected recession starting in the second half of 2023. 

In the minutes FOMC participants noted that goods inflation had slowed in recent months, but that the contribution of goods prices to disinflation was expected to moderate. Other components of inflation remained of concern: “Participants agreed that they had observed less evidence of a slowdown in the rate of increase of prices for core services excluding housing, a category that accounts for more than half of the core PCE price index. Participants judged that as long as the labor market remained very tight, wage growth in excess of 2% inflation and trend productivity growth would likely continue to put upward pressure on some prices in this component.” Thus, participants think that further fed funds rate hikes are needed to cool off job growth.

In discussing the economy outlook, participants said that “recent indicators pointed to modest growth in spending and production,” but also noted strong job growth and a low unemployment rate. The minutes say that previous increases in the fed funds rate had been weighing on growth in interest-rate-sensitive industries, particularly housing. The minutes noted that real GDP growth in 2022 was below trend, and participants “expected that real GDP growth would slow further in 2023.” In particular, consumer spending “would likely grow at a subdued rate in 2023,” and higher interest rates would weigh on investment spending this year.

The strong labor market remained a major concern. “Participants agreed that the labor market remained very tight and assessed that labor demand substantially exceeded the supply of available workers.” The minutes also say that recent tech layoffs “did not appear to reflect widespread weakness in the demand for labor.” According to the minutes, “under appropriate monetary policy, participants expected labor market demand and supply to come into better balance over time, easing upward pressure on nominal wages and prices.”

Although the decision to increase the fed funds rate on February 1 was unanimous, the minutes do say that “a few participants stated that they favored raising the target range for the federal funds rate 50 basis points at this meeting or that they could have supported raising the target by that amount. The participants favoring a 50-basis point increase noted that a larger increase would more quickly bring the target range close to the levels they believed would achieve a sufficiently restrictive stance, taking into account their views of the risks to achieving price stability in a timely way.”