Many analysts believe inflation has peaked and that prices will fall in the near future, allowing the US Fed and other central banks to roll back some of the interest-rate hikes by the end of this year.
The Federal Reserve had done this in 2019 just seven months after its last hike.
However, the Fed says it is too early to think about cutting interest rates this year because inflation is still higher than its target range.
The big question mark for financial markets in 2023 is how the clash between hopes of an interest rate cut and the Fed’s policy will ultimately resolve.
In this article
- Has inflation peaked?
- Inflation remains a worry in Australia
- Shortage of workers driving wage growth
- A hike before a pause
Raising interest rates is a monetary policy tool that helps suppress demand in the economy, thereby helping cool the inflation rate.
US inflation continued to decline in December 2022, adding to the argument that price pressures have peaked.
The overall consumer price index (CPI) fell 0.1% from the prior month, with cheaper energy costs helping achieve the first decline in 2-1/2 years.
Although inflation was up 6.5% compared to last year, it was the lowest since October 2021.
Excluding food and energy, the core CPI gained 0.3% last month and was up 5.7% from a year earlier, the slowest pace since December 2021.
The latest data point to more consistent signs that inflation is easing and some analysts see the Fed downshift to a quarter-point hike at their next meeting ending February 1.
Inflation remains a worry in Australia
In Australia, markets had predicted last year that the RBA would raise its cash rate to as high as 4.25%.
However, recent market prediction has cut this to about 3.72%.
Analysts are not sure about what will happen at the RBA’s meeting on February 7 – it could be another increase of 25 basis points (which has an implied probability of 65%) or a pause.
After falling to 6.9% in October, the return of inflation to 7.3% in November was disappointing and highlights the fact that inflation in Australia is not going to be a pushover for the RBA as it tries to squeeze it back to its 2-3% target.
The recent rapid increase in interest rates in Australia has led to a record fall in home values due to reduced borrowing capacity and higher interest costs. In addition, higher household debt and decreased household savings have lowered consumer sentiment and demand for housing. https://t.co/N0n7Z552hR— Dominic (@Pirrello) January 9, 2023
Shortage of workers driving wage growth
It may be too early to declare that the fight against inflation is over.
Strong consumer demand, particularly for services, combined with a tight labour market continues to keep upward pressure on prices.
The US Bureau of Labor Statistics recently reported that the unemployment rate had hit a 53-year low, falling to 3.5%.
This low unemployment rate is making it difficult for companies to find workers, which can be seen in the 10.5 million job openings reported by the bureau.
The shortage of workers is causing many employers to increase wages.
Although that's good news for workers, those pay increases are most likely translating into higher prices for customers.
“To be clear, strong wage growth is a good thing,” Fed chair Jerome Powell said at a conference in November.
“But for wage growth to be sustainable, it needs to be consistent with 2% inflation,” he added.
A hike before a pause
Many economists expect the Fed to raise interest rates further before pausing to assess how the most aggressive tightening cycle in decades is impacting the economy.
At the meeting in December, Fed officials projected interest rates would continue rising through the spring, to around 5.1%.
FYI: the Fed is not going to cut interest rates unless there is a recession and/or crisis— Callum Thomas (@Callum_Thomas) January 16, 2023
Michelle Bowman, a member of the US Federal Reserve Board of Governors, said the US Federal Reserve would continue tightening monetary policy by raising key interest rates even though there had been a decline in consumer inflation.
“In recent months, we’ve seen a decline in some measures of inflation but we have a lot more work to do, so I expect the FOMC will continue raising interest rates to tighten monetary policy, as we stated after our December meeting,” Bowman said.
“My views on the appropriate size of future rate increases and on the ultimate level of the federal funds rate will continue to be guided by the incoming data and its implications for the outlook for inflation and economic activity.”