By Indradeep Ghosh
BENGALURU (Reuters) – The Federal Reserve will raise its key interest rate to a much higher peak than expected two weeks ago, and the risks are tilted toward a higher interest rate, economists polled by Reuters said.
The change in expectations came after the Federal Reserve raised interest rates by 75 basis points last week for the third consecutive meeting and projected a higher than previously thought to tame inflation, which is more than four times the target.
Since then, battered global stocks have already delved deeper into bear market territory – down 20% or more – amid recession fears and most currencies have slipped further against the multi-decade high dollar.
But that is unlikely to prompt the Fed to change its policy course any time soon, as Fed Chairman Jerome Powell and other policymakers have remained vocal about the upcoming “pain.”
In fact, more than 70% of economists, 59 out of 83, expected the central bank to raise the federal funds rate by three-quarters of a percentage point for the fourth consecutive meeting in November, a Reuters poll after last week’s Fed meeting showed.
The poll expected it to follow 50 basis points in December to end the year at 4.25%-4.50%.
If achieved, it would be the highest rate since early 2008, before the worst of the global financial crisis, and 75 basis points higher than the 3.50%-3.75% projected just two weeks ago. The forecasts are in line with the Fed’s point chart projection and current market pricing.
“With inflation so high, history says you need to get to it sooner and follow through. The real policy mistake is not to bring inflation back to 2%,” said Michael Gaben, chief US economist at Bank of America Securities.
“If a near-term recession and a larger increase in the unemployment rate than they expect are necessary to bring down inflation, it is not a policy error in their minds.”
A poll conducted earlier this month put the probability of a recession in the US over the next year at 45%, with the probability of a recession in the next two years at 55%.
The majority, 45 of 83 economists, expected the fed funds rate to peak at 4.50%-4.75% or higher in the first quarter of 2023, the same as the point chart projection and above the estimated neutral level of 2.4% that neither stimulates nor constrains economic activity. .
All but two of the 51 economists who answered an additional question said the risks are skewed toward a higher interest rate than they currently expect.
Justin Widener, an American economist at German Bank (ETR :), which expects the rate to peak at 4.75%-5.00%.
“The short-term pain of stagnation will be better than the long-term pain of inflation expectations becoming unconstrained.”
Also, unlike most major central banks, the Fed is backed by a strong currency and a relatively strong economy compared to its peers.
Among economists who had a view to the end of 2023, only 46% expected at least one rate cut.
With inflation not seen below the central bank’s target anytime soon, and the unemployment rate, currently 3.7%, expected to rise much more slowly than in previous recessions, an early cut could damage the Fed’s credibility.
More than 80% of respondents said that once the Fed funds rate peaks, it is more likely to leave the central bank unchanged for an extended period than to cut it quickly.
The rates were expected to remain in the restricted area until at least 2026.
“To bring down (inflation), the economy needs to run below potential, keeping demand in better equilibrium with supply capacity,” said James Knightley, chief international economist at ING.
“The only way the Fed can do that is to raise interest rates and maintain a restrictive policy until that happens.”
(For other stories from the Reuters World Economic Poll 🙂