Fed needs to see wage growth falling to levels compatible with inflation target: Expert

By Ovunc Kutlu

ISTANBUL (AA) – The US Federal Reserve needs to see wage growth coming down to the levels compatible with its 2% inflation target, according to an expert.

The central bank last Wednesday raised its benchmark interest rate by 50 basis points, as expected, in its fight against record inflation, carrying the target range for the federal funds rate to between 4.25% and 4.5% – its highest in 15 years.

"Overall, the Fed did what we thought they would do, which is to slow the pace of hiking as signs point to decelerating inflation," Martin Wurm, a director at Moody's Analytics, told Anadolu Agency via email.

"Policymakers also sent a hawkish message – in this case by signaling that the FOMC expects the Fed funds rate will breach 5% in 2023, which is above market expectations," he added.

The terminal rate, the peak spot where the federal funds rate is expected to climb before they are trimmed, was raised to 5.1% for 2023, from an estimate of 4.6% in September, according to the Federal Open Market Committee (FOMC) members' projections.

The FOMC also lowered the real gross domestic product growth projection for 2023, as it now expects the American economy to grow 0.5% next year, down from its previous forecast of 1.2% growth in September.

- Soft-landing or recession?

Many economists are worried that the Fed's aggressive monetary tightening, a total of 425 basis points, or 4.25%, of rate hikes since March could make it difficult to achieve soft-landing – a process where a central bank increases interest rates to lower inflation and causes an economic slowdown but avoids a recession.

"The Fed's hope for a soft landing is that this can be accomplished by reducing the large number of job openings in the US job market instead of mass layoffs, avoiding a significant increase in the unemployment rate," Wurm said.

"If that will play out is anyone's guess at this point, but that would be the best case outcome. Historically, most disinflation episodes result in some kind of recession, but that has not always been the case, and the fundamental sectors of the US economy are still in good shape," he added.

Unemployment rate in the US remained unchanged at 3.7% in November, compared to the previous month, and close to the 29-month low of 3.5% in September.

"As fears about the economy dipping into a recession grow, we are starting to see more modest rate hikes being implemented," Ben McLaughlin, president of online savings marketplace, SaveBetter.com, said in an email note.

"The Fed is walking a fine line between curbing inflation and trying to prevent the US from going into a recession in 2023, and we will see how the latest hike will influence the overall economy and labor market," he added.

Fed Chair Jerome Powell, in his post-meeting press conference, told that American economy slowed from last year, while job vacancies still remain high and wage growth elevated.

- 'Labor market driving much of non-shelter service inflation'

Powell also stressed that more macroeconomic data is needed to prove inflation is falling. "It will take substantially more evidence to give confidence that inflation is on a sustained downward path," he said, as price pressures "remain evident."

"It is not important how fast we go, it is far more important to think what is the ultimate level," he said, adding that the ultimate question will be how long the Fed will remain restrictive in its monetary policy.

The Fed chair noted that inflation can be broken down into three levels – goods inflation, housing services and non-housing related core services that make up 55% of the personal consumption expenditures index.

Wurm said he agrees with the Fed's assessment that goods inflation is turning and shelter inflation will turn in the next year, and noted that "the biggest source of concern remains the labor market which is driving much of non-shelter service inflation."

"The latter has not turned in meaningful ways and until it does inflation cannot return to its target," he added.

Annual consumer inflation in the US came in at 7.1% in November – the smallest 12-month increase since December 2021 – and it is a sharp decline from a 9.1% yearly gain in June, which had been the largest 12-month increase since November 1981.

The figure, however, is still too far away from the Fed's inflation target of 2%.