Fed Minutes Show Most Officials Favored Quarter-Point Rate Rise

Stronger economic conditions have boosted investors’ expectations for higher rates this year

Federal Reserve officials are signalling that a resilient U.S. economy could lead them to raise interest rates somewhat higher than they had anticipated to conquer high inflation.

Officials at their meeting earlier this month agreed to slow rate increases by lifting their benchmark federal-funds rate by a quarter-percentage point, following larger moves of a half point in December and 0.75 point in November.

Minutes from that meeting, released Wednesday, showed most thought a slower pace provided the best way to manage the risks of raising rates too much or too little. But the minutes also revealed some officials were concerned about stopping or slowing their inflation-fighting campaign too soon.

“A number of participants observed that a policy stance that proved to be insufficiently restrictive could halt recent progress in moderating inflationary pressures,” said the minutes of the Jan. 31-Feb. 1 meeting, released Wednesday.

The latest increase brought the fed-funds rate to a range between 4.5% and 4.75%, extending the fastest series of rate rises since the early 1980s.

While the quarter-point rate rise was backed unanimously by the rate-setting committee, the minutes said a few officials favored or would have also agreed to support a half-point increase.

Cleveland Fed President Loretta Mester and St. Louis Fed President James Bullard, who don’t vote on rate decisions this year, last week said they thought a larger increase was warranted because it would move the rate more quickly to their estimate of the necessary peak level.

“I don’t see much merit in delaying our approach to that level” of around 5.4%, said Mr. Bullard. Ms. Mester said officials aren’t limited to continuing to move in quarter-point steps.

But the minutes suggest a high bar for the Fed to resume half-point rate rises, analysts said Wednesday.

Richmond Fed President Tom Barkin told reporters last week he didn’t favor a strategy of moving rapidly to an estimated peak rate before pausing rate increases because he isn’t confident the central bank can gauge how much its past rate moves are slowing the economy. “That theory, to me, requires more confidence in understanding” the effectiveness of tighter rate policy “than I have,” he said.

Since the meeting, new data indicated stronger economic activity and slower progress on reducing inflation than forecast, which could keep the Fed raising rates longer than previously anticipated.

Hiring and retail spending surged in January. The unemployment rate fell to 3.4%, a 53-year low, surprising economists who have long anticipated that Fed rate increases would slow the economy soon. Economic growth also has rebounded in Europe, further easing worries of a global recession this year.

Inflation’s decline late last year stalled in January, and data revisions further indicated the drop in recent months wasn’t as swift as initially reported. The 12-month inflation rate edged down to 6.4% last month from 6.5% in December and a recent high of 9.1% in June, according to the Labor Department’s consumer-price index.

The Commerce Department is set to release its reading of the Fed’s preferred inflation gauge, the personal-consumption expenditures price index, on Friday. Several Wall Street forecasters expect it to show that core prices, which exclude volatile food and energy prices, rose a sturdy 0.5% in January from a month earlier.

Fed staff economists at the recent meeting reduced their projection for inflation this year because they forecast slower growth. But Fed policy makers cited several risks that inflation might not decline as quickly as hoped this year, including due to tighter labor markets in the U.S. or from stronger growth abroad, especially after China abandoned its Covid lockdown policies.

Most Fed officials projected in December that they would raise the fed-funds rate to 5.1% this year, which would imply quarter-point rate increases at their next two meetings, in March and May. More than a third of officials anticipated lifting the rate above 5.25%. None projected rate cuts this year.

Officials are set to release new forecasts at the conclusion of their meeting March 21-22, when another quarter-point rate increase is widely anticipated.

The Fed raises rates to combat inflation by slowing the economy through tighter financial conditions—such as higher borrowing costs, lower stock prices and a stronger dollar—that curb demand.

At the time of the recent meeting, Fed Chair Jerome Powell was facing increasing skepticism from investors over whether the central bank would continue raising rates because economic activity had been mixed around year’s end, with signs that consumer spending had moderated and weakness in the hard-hit housing sector was spreading to manufacturing. Investors were also anticipating rate cuts later this year.

Some officials at the meeting observed that any continued easing in financial conditions could require the Fed to raise rates to higher levels or keep them at higher levels for longer than anticipated.

But stronger growth has led investors to radically rethink the policy outlook for the coming year. Investors now expect the Fed to lift the fed-funds rate by a quarter point at each of its next three meetings, to around 5.4% by June.

Investors’ shifting expectations about the Fed could already be helping the central bank because interest-rate policies work through financial markets. Changes to the anticipated trajectory of rates, and not just what the Fed does at any meeting, can influence broader financial conditions.

Since November, anticipation of a milder interest-rate path led financial conditions to ease somewhat after tightening substantially last year. The average 30-year fixed mortgage rate, for example, jumped from 4% one year ago to 7% in November. It then edged lower, to around 6% earlier this month.

Over the past two weeks, however, financial conditions have tightened again as investors anticipate an interval of higher short-term interest rates. Mortgage lenders have reported rates are returning back to 7% in recent days.