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The Fed, Staring Down Two Big Choices, Charts an Aggressive Path

Federal Reserve officials have coalesced around a plan to raise interest rates by three quarters of a point next month as policymakers grow alarmed by the staying power of rapid price increases — and increasingly worried that inflation is now feeding on itself.

Such concerns could also prompt the Fed to raise rates at least slightly higher next year than previously forecast as officials face two huge choices at their coming meetings: when to slow rapid rate increases and when to stop them altogether.

Central bankers had expected to debate slowing down at their November meeting, but a rash of recent data suggesting that the labor market is still strong and that inflation is unrelenting has them poised to delay serious discussion of a smaller move for at least a month. The conversation about whether to scale back is now more likely to happen in December. Investors have entirely priced in a fourth consecutive three-quarter point move at the Fed’s Nov. 1-2 meeting, and officials have made no effort to change that expectation.

Officials may also feel the need to push rates higher than they had expected as recently as September, as inflation remains stubborn even in the face of substantial moves to try to wrestle it under control. While the central bank had penciled in a peak rate of 4.6 next year, that could nudge up depending on incoming data. Rates are now set around 3.1 percent, and the Fed’s next forecast will be released in December.

Credit…John Taggart for The New York Times

Officials are afraid that if they allow fast inflation to linger, it will become a permanent feature of the American economy. Workers might ask for bigger wage increases each year if they think that costs will steadily increase. Companies, anticipating higher wage bills and feeling confident that consumers will not be shocked by price increases, might increase what they’re charging more drastically and regularly.

“The longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched,” Mr. Powell warned at his news conference last month.

There are mounting signs in the data that today’s inflation is less and less the result of one-off trends that are likely to fade on their own over time. Supply chains are healing, and shipping costs that had spiked have come back down, but consumer prices continue to increase rapidly month after month. Those increases are driven by a broad array of goods and services, including climbing housing costs, pet care services and dental visits.

In their latest meeting minutes, officials acknowledged that “inflation was declining more slowly than they had previously been anticipating” and that price pressures “had persisted across a broad array of product categories.” Since then, inflation has only shown signs of deepening: Even measures of inflation that try to strip out noise in the data are unusually firm.

And there is little evidence, so far, that the Fed’s policy is working to tamp down price increases. Fed moves take time to play out, but their effects are already pretty clear in overall economic data: The housing market is slowing sharply, demand is beginning to pull back and people are eating into their savings stockpiles. Yet prices have shown little reaction to those trends.

“We haven’t yet made meaningful progress on inflation,” Christopher Waller, a Fed governor, said during a recent speech.

If that continues, it could force Fed officials to do more next year to constrain rate increases. James Bullard, the president of the Federal Reserve Bank of St. Louis and a voter on policy this year, signaled in an interview with Reuters last week that he might favor another big three-quarter point rate increase in December — taking the policy rate to around 4.6 percent — and then further moves next year.

It’s “very possible” that incoming data could push officials “higher on the policy rate,” he said. He said it was also possible that price increases would begin to fade, however, allowing for a pause.

Nathan Sheets, global chief economist at Citi, expects that Fed officials will slow their rate increases in line with their most recent economic projections: moving by three-quarters of a point in November, half a point in December and a quarter point early in 2023 before pausing. But he said there were notable risks that they end up raising rates by more.

“The Fed has struggled to explain that even if it hikes by less than three quarters of a point, it remains determined to fight against inflation,” Mr. Sheets said.

Credit…Anna Moneymaker/Getty s

The central bank does not want investors to believe that its dedication to fighting inflation is beginning to crack. If market players think that, financial conditions might ease, making credit cheaper and more available and working at cross purposes to the Fed’s goals. That happened after Mr. Powell’s July news conference, when the chair hinted that rate increases might soon slow, and investors incorrectly began to expect an imminent central bank retreat.

“When he opened the door to it, the market said, ‘Aha! The Fed’s pivoting,’” Mr. Sheets said. “It’s been a tricky message so far.”

Of course, there are some reasons to hope that the inflation picture could change, which would give the Fed a more clear-cut reason to slow down.

Used car prices are coming down at a wholesale level, and that could begin to more fully feed into consumer prices. Retailers are announcing discounts as inventories pile up. Companies, which continue to rake in unusually high profits as they manage to charge more than their goods and services cost to produce, are expected to slash their profit guidance as consumers begin to pull back.

There are also some nascent signs that the labor market is cooling back to something more normal. Job openings have begun to come down, and average hourly earnings have shown signs of moderating.

But hiring has persisted at an unusually rapid pace, and a quarterly measure of wages and benefit compensation that the Fed puts greater stock in — the Employment Cost Index — has continued to climb rapidly. That could keep pressure on service prices, as restaurants and health care providers try to cover rising labor bills, and higher pay could help consumers to keep spending.

At the same time, new problems could emerge: Gas prices have risen again this month, for instance, and their future trajectory is uncertain.

Recent history offers plenty of reasons for caution. The Fed has spent 18 months hoping that inflation would soon abate, only to have that expectation repeatedly dashed by reality.

But with an outlook that is so uncertain, officials have emphasized in recent speeches that policy will be made on a meeting-by-meeting basis — one reason it is too soon to say whether a fifth big rate move in December will be appropriate.

“The outlook for inflation and economic activity is subject to unusual uncertainty,” Michelle Bowman, a Fed governor, said in a speech last week. “We should continue to reiterate that we will remain ‘highly attentive to inflation risks.’ This is probably the best and clearest forward guidance we can provide at this point.”

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