The Federal Reserve is on the cusp of doing what some thought was impossible: Beating inflation without a deep recession

WASHINGTON (AP) — It was the most painful inflation Americans had experienced since 1981, when “The Dukes of Hazzard” and “The Jeffersons” topped the TV charts. But now the Federal Reserve appears to be on the verge of defeating them – and without the rise in unemployment and the deep recession that many economists had predicted.

Inflation has fallen more or less steadily since peaking at 9.1% in June last year. And when the Fed’s preferred inflation measure for November is announced next week, it is likely to show that annual inflation has actually fallen just below the Fed’s 2% target over the past six months, economists at UBS estimate.

The cost of goods – such as used cars, furniture and appliances – has fallen for six months in a row. Compared to last year, goods prices are unchanged and are being kept low by improved global supply chains.

Housing and rental costs, a key driver of inflation, are rising more slowly. Wage growth has also moderated, although it still outpaces inflation. Milder wage growth tends to ease pressure on restaurants, hotels and other employers to raise their prices to cover their labor costs.

“I think it’s really good to see the progress we’re making,” Chairman Jerome Powell said at a news conference Wednesday after the Fed’s latest policy meeting. “If you look at the … six-month measures, you see very low numbers.”

On Friday, the Congressional Budget Office, a nonpartisan agency, estimated that inflation will fall to 2.1% by the end of next year.

There will likely be difficulties on the path to fully controlling inflation, officials said. Powell emphasized that “no one is declaring victory.” And he reiterated that the central bank wants to see further signs of falling inflation before it is confident it will sustainably return to the 2 percent target.

But many economists, usually cautious, are now poised to declare that inflation is almost back under control after more than two years of wreaking havoc on millions of American households.

“It appears that inflation has returned to 2%,” said Tim Duy, chief economist at SGH Macroeconomics. “The Fed appears to have won this battle.”

Price spikes are also easing abroad, with both the Bank of England and the European Central Bank leaving their key interest rates unchanged this week. Although inflation is still at 4.6% in the UK, it has fallen to 2.4% in the 20 countries that use the euro.

With inflation cooling, Powell said the 19 officials on the Fed’s monetary policy committee discussed the prospects for rate cuts at this week’s meeting. Officials also predicted the Fed will cut its key interest rate three times next year.

This stance marked a drastic departure from the interest rate hike campaign that the Fed began in March 2022. To that end, the central bank raised its key interest rate 11 times from near zero to about 5.4%, the highest in 22 years of slow borrowing, spending and inflation. The result was significantly higher costs for mortgages, auto loans, business loans and other forms of credit.

Powell’s suddenly more optimistic words and the Fed’s rate cut forecasts sent stock market indexes soaring this week. Wall Street traders now believe there is about an 80% chance of the first rate cut coming at the Fed’s March meeting, and they are forecasting a total of six rate cuts in 2024.

On Friday, John Williams, president of the Federal Reserve Bank of New York and a top Powell lieutenant, tried to counter those expectations. On CNBC, Williams said it was “premature to even think” about cutting rates in March. But he also mentioned that his forecast was that inflation would fall “sustainably” to 2%.

This week’s events marked a departure from just two weeks ago, when Powell had said it was “premature” to say whether the Fed had raised its interest rate high enough to fully combat high inflation. On Wednesday, he suggested that the Fed was almost certainly done raising interest rates.

Recent data appeared to have helped change Powell’s thinking. On Wednesday, wholesale prices were lower than economists expected. Some of these numbers are used to create the Fed’s preferred inflation measure, which is therefore expected to show significantly lower inflation numbers next week.

Powell said some Fed officials even updated their economic forecasts on Wednesday, shortly before their release, in light of the lower-than-expected wholesale price report.

“The speed at which inflation has fallen has been like an earthquake for the Fed,” Duy wrote in a note to clients on Wednesday.

And yet, in the meantime, the economy continues to grow, defying widespread fears a year ago that 2023 would bring a recession, a result of the much higher borrowing rates brought about by the Fed. A retail sales report on Thursday showed that consumers increased their spending last month, likely spurred by increased markdowns that will also reduce inflation. Such trends support the growing belief that the economy will reach an elusive “soft landing” in which inflation is beaten without triggering a recession.

“We believe the Fed can’t believe its luck: we’re back to ‘impeccable disinflation,’” Krishna Guha, an economic analyst at investment bank Evercore ISI, wrote in a note to clients.

Economists credit the Fed’s rapid rate hikes with helping to reduce inflation. In addition, a recovery in global supply chains and an increase in the number of Americans – and new immigrants – looking for work have helped moderate the pace of wage growth.

Jon Steinsson, an economics professor at the University of California, Berkeley, said Fed officials had largely kept Americans’ inflation expectations in check by aggressively raising their key interest rate in about 15 months – the fastest such pace in four decades . Expectations can be self-fulfilling: When people expect higher inflation, they often take actions, such as demanding higher wages, that can push prices even higher.

“You played a crucial role,” said Steinsson.

However, a sustained decline in inflation is not guaranteed. The rental prices are a wild card. Real-time measurements of new residential rental agreements show that these costs are rising much more slowly than a year ago. It takes time for this data to be incorporated into the government’s figures. In fact, inflation rose just 1.4% year-on-year last month, excluding what the government calls “accommodation” costs – rent, home ownership costs and hotel prices.

But Kathy Bostjancic, an economist at Nationwide, said she fears a lack of available housing in the coming years could increase housing costs and potentially further increase inflation.

Bostjancic said the Fed’s rate hikes could actually prolong the shortage. Today’s higher mortgage rates may limit home building while discouraging existing homeowners from selling. Both trends would keep housing supply under control and prices high.

Still, Fed officials appear confident in their forecasts that inflation is steadily slowing. In September, 14 of 19 Fed policymakers said there was a risk that inflation could rise faster than expected. This month only eight said that.

“Their forecasts have mostly gone down, and they believe there is less chance of a rise in inflation,” said Preston Mui, senior economist at Employ America, an advocacy group.