Some Fed policymakers and economists fear that the easing of inflation will be temporary. They see the slowdown in inflation as long overdue after the pandemic-related shocks that drove up rents, transport and car prices. And they worry that underlying price pressures could persist, requiring the Fed to lift rates higher and hold them there longer.
Other economists argue that the thinking ignores the signs of the current economic slowdown, which will gradually dampen price pressures. They also argue that inflation will slow enough to push "real" or inflation-adjusted interest rates higher in the months ahead. This would provide additional monetary restraint, even if this year's rate hike is the last of the current tightening cycle.
Rising interest rates slowing the economy
Rising interest rates slow down the economy through financial markets by lowering asset prices and raising the cost of borrowing. Inflation cooled last month to the slowest pace in two years. The consumer price index climbed 3% in June from a year earlier, well below its recent peak of 9.1% in June 2022. The core inflation index, which excludes volatile food and energy prices, also posted its smallest monthly increase in more than two years in June.
Catching up on inflation-adjusted wage growth
One side of economists says there is too little scarcity and too much demand in the economy to be reasonably confident that inflation will return to the Fed's 2% inflation target in the next few years. They don't share investors' recent optimism that inflation can moderate sustainably without a broader economic slowdown, though they concede that the incoming data could bolster hopes that the Fed can achieve a so-called soft landing, where it reins in price pressures without sending the economy into recession.
Many of these economists worry that wage growth is too strong. Without a recession, they see a tight labor market pushing up core inflation next year. Since an overheated labor market is likely to show up first in wages, many see wage increases as a good indicator of underlying inflationary pressure.
Wages and wages continue to rise
Wages and salaries rose 5% in the January-to-March period from a year earlier, according to the Labor Department's Employment Cost Index. The Fed closely monitors this index because it is the most comprehensive measure of wage growth.
The big question is whether workers in a tight labour market will accept minimal inflation-adjusted wage increases after two years when their wages have not kept pace with inflation.
Some signs of easing labour markets
The other camp of economists believes there is ample evidence that the labour market is cooling, reducing pressure on inflation.
The time it takes unemployed workers to find a new job is increasing. The increase in hours worked by private sector employees has slowed along with the number of unfilled jobs. "This points to a labour market that is indeed seriously slowing down
Monthly private sector hiring eased to an average of 215,000 jobs in the first half of this year, from 317,000 in the second half of 2022 and 436,000 in the first half of 2022. If the labor market continues to add 200,000 positions per month, it will signal the Fed to keep rates higher for longer.