At its December meeting the Federal Reserve (Fed, the central bank) raised its policy rate to a target range of 4.25-4.5%— an increase of 50 basis points. This is the first deceleration since the Fed started raising rates in March 2022 and follows four consecutive 75-basis-point increases between June and November. 

Why does it matter?

The moderation in the pace of tightening suggests that the Fed considers inflationary pressure to have stabilised compared with recent months. This fits with our view that the Fed will continue to slow the pace of rate rises, making two final 25-basis-point increases in the first quarter of 2023, before pausing in March to take stock of the effect of rate rises thus far. However, the Fed is still in tightening mode—a 50-basis-point rise remains quite an aggressive increase by US standards.

The Fed chairman, Jerome Powell, continued to highlight the strength of the US labour market and economic activity, cautioning that the end of the tightening cycle was still some way off. However, he pointed to softening inflation data from October and November as a sign that inflation was starting to abate overall. As we had expected, this allowed the Fed to justify a more moderate pace of tightening in December. We expect this trend to continue in January-March 2023 as inflation continues to decelerate in year-on-year terms and consumer spending slows sharply.

Nonetheless, several pockets of inflationary pressure remain, particularly housing costs. Housing was the main contributor to inflation in the past two months, rising by 0.8% month on month in October and a slightly more modest 0.6% in November (up by 7.1% in annual terms). However, we expect housing costs to start declining next year; the cost of new rental contracts (which only have a minor impact on the market average currently) has declined significantly in the past six months. Data from several private companies that monitor the real estate market, including Zillow and Redfin, show that the cost of new rental contracts was up by about 9% year on year in September, down from 18% annual growth in March. As new annual prices filter through the market, lower housing costs will push inflation down more noticeably by mid-2023. However, the final segment of the price basket, non-housing services (particularly healthcare), will continue to be pushed up by recent wage growth. This will prevent a sharper slowdown in inflation in 2023. 

What next?

We continue to expect inflation to average 8% in 2022 and 3.7% in 2024. If it does not continue to moderate as we expect, the Fed may raise its policy rate above our current forecast for the peak range, of 4.75‑5%.

The analysis and forecasts featured in this piece can be found in EIU’s Country Analysis service. This integrated solution provides unmatched global insights covering the political and economic outlook for nearly 200 countries, helping organisations identify prospective opportunities and potential risks.