The chairman of the Federal Reserve (Fed, the central bank), Jerome Powell, reiterated his recent hawkish language at two international policy conferences at end-June. He suggested that further interest-rate increases were likely in the coming months. Data published on June 30th showed that personal consumption expenditure (PCE) inflation—the Fed’s preferred measure—remained high in May, confirming the high likelihood of additional tightening.

Although US economic data have been mixed for months, the Fed remains focused on inflation, particularly sticky core inflation, to inform its policy decisions. Those data suggest, at least for now, that further monetary tightening is likely in the coming months. Headline PCE inflation eased noticeably in May, to 3.8% year on year, from 4.7% in April. However, core PCE inflation (which excludes more volatile energy and food prices) remained stubbornly high, at 4.6% in May, after having held at 4.6-4.7% since January.

As a result, we now expect the Fed to raise interest rates by another 25 basis points at its July meeting, to a range of 5.25-5.5%. There is a high chance of a final 25-basis-point rise in September or November, if inflation and wage growth continue to run hot. At the Fed’s June meeting, a majority of rate-setting committee members projected that another 50 basis points of tightening would be needed. However, given the clearer downward trend in headline inflation in recent months, as well as an expected drop-off in rental price growth in the second half of the year, we currently expect the final rate rise to be in July.

We expect lending conditions to tighten further in the coming months as banks adjust to the likelihood that monetary policy will remain tighter for longer than they initially assumed. We have long expected that the Fed would reach a peak policy rate around mid-2023 and keep rates at this peak until mid-2024, with the first cut coming at the start of the third quarter. By that time we expect that US economic activity, and particularly consumer spending, will have slowed sharply, to about 1% per year on average in 2023‑24. Although this will increase pressure on the Fed to ease policy and support GDP growth, we expect that the Fed will wait to see clear signs that inflation has been anchored at about 2% before cutting, to avoid a repeat of 1970s-era stagflation.

We will revise up our forecast for the peak fed funds rate to 5.25-5.5%. For now, we expect that a gradual slowdown in core inflation and tighter lending conditions will make further rate increases unnecessary in 2023, but risks to this forecast are high.

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