Volkswacht Bodensee - Cooling US inflation lifts hope for smaller Fed rate hike

As consumer inflation rocketed to decades-high levels last year, the Federal Reserve raised rates seven times in an aggressive campaign to cool the world's biggest economy and lower costs.

Since then, the interest-sensitive property sector has slumped, retail sales have weakened and wage growth has started to ease, prompting some Fed policymakers to suggest it may be time to slow the pace of rate hikes further.

"A slower pace of rate hikes will give the committee time to assess the full economic effects of monetary tightening thus far," said Moody's Investors Service in a report.

Markets expect the Fed to adopt a 25-basis-point hike at the end of a two-day meeting Wednesday, slowing the pace of increases for a second time in a row.

This would take the benchmark lending rate to 4.50-4.75 percent, a level last seen in 2007. In December, the Fed announced a 50-basis-point hike, stepping down from four earlier, steeper spikes.

"They are seeing the desired effects of policy," Rubeela Farooqi of High Frequency Economics told AFP.

"They don't want to keep on pushing until they get the economy into a recession," she said.

- 'Far from won' -

But the inflation fight "is far from won," warned the Moody's report.

Although demand appears to be moderating and supply bottlenecks have eased, spending has been stronger than expected.

This has prevented inflation from falling more rapidly and suggests the Fed's "terminal rate" -- the level at which it will halt its increases -- remains uncertain.

For inflation to come down to the Fed's target, "we will need a little bit of softening in the labor market," Madhavi Bokil of Moody’s Investors Service told AFP. This could show up in a slower pace of hiring and fewer vacancies.

Wages do not appear to be driving inflation up, but they do lend some support to consumer spending as households draw down on pandemic-era savings.

Salary gains remained high last year, while employers were reluctant to shed workers they may have struggled to find since the pandemic, keeping the labor market tight.

- 'Soft landing' -

On the other hand, the fact that the labor market has not slumped in response to tightening monetary policy brings optimism for a "soft landing" of the economy, where inflation comes down without triggering significant job losses or a major downturn.

"No one ever said that arranging a soft landing is easy, but our base case remains that if the Fed stops raising rates soon, the risk of a severe recession is quite small," said Ian Shepherdson of Pantheon Macroeconomics.

If the Fed raises rates too far, a "bigger danger" would be an unnecessary recession, he said.

"However much the Fed might want to be sure the inflation demon is put back in its box," dragging inflation below policymakers' two percent target and an "accompanying rise in unemployment would represent a policy failure," said Shepherdson.

L.Janezki--BTB