The US Federal Reserve is taking a break from raising interest rates

American inflation appears to be declining at high levels, but the Fed obviously remains suspicious. On Wednesday it stopped tightening the interest rate screw for the first time in 15 months after ten, sometimes strong, turns in a row, but to a certain extent it still has the wrench in its hand.

According to the official announcement, Fed President Jerome Powell and the institution’s interest rate-setting committee want to wait and see what further effects the past interest rate increases will have on the economy. Above all, they first want to see whether the recent bank collapses will cause further waves and possibly slow down lending more. That would be a warning sign. At the same time, price inflation is still twice the desired inflation target of 2 percent, so central bankers tend to raise interest rates again in July or September.

“It should not be forgotten that most inflation forecasts over the past two years have been completely wrong. We simply don’t see the core inflation rate falling any further at the moment – and that’s what we’re looking at,” said Fed President Jerome Powell in the press conference after the decision was announced.

Don’t repeat the mistake of 50 years ago

Monetary politicians are determined to avoid the mistake that the central bank made a good 50 years ago when it reacted too quickly to rapidly and significantly falling producer and consumer prices and relaxed the monetary policy framework too early. A little later, it had to brake even harder when the inflation rate suddenly shot up again after a brief setback.

Today the Fed faces a similar dilemma. Investors in the financial markets are seeing falling price increases, they have been expecting a recession for a while and that the central bank will soon open the “money floodgate” again. For this reason, they buy stocks and bonds. But that is exactly what ensures a generous monetary policy framework in general, which counteracts the Fed’s intentions to slow the economy in view of a record-low unemployment rate and a hot service sector.

Various estimates come to the conclusion that economic growth in the current quarter is around 2 percent on an annual basis. The interest-sensitive real estate market appears to be stabilizing, and in some regions house prices are tending to rise again. Ultimately, many homeowners are unwilling to move and give up their contracts with current low mortgage interest rates. In this way, demand is directed towards newly built buildings, whereupon employment in the construction industry increases and the share prices of house building companies rise significantly. Construction investments in the commercial sector are booming.

“Growth is not declining more significantly because the American economy is still driven by fiscal stimulus,” says Robert Kaplan, former president of the Federal Reserve Bank of Dallas. The federal government may have largely spent the 2020 American Rescue Act funds, but states and local governments still have those funds in the pipeline. However, since these must be spent by 2025 at the latest before the entitlements expire, the beneficiaries are in the process of improving their infrastructure or investing in new projects.

Constellation can cause all sorts of surprises

There are also the huge funds from the Chips and Science Act, the Inflation Reduction Act and the Infrastructure Investment and Jobs Act. These would theoretically be suitable for pulling the economy out of a recession, although the economy is still overheated. So it happens that these stimulus measures also run counter to the Fed’s key interest rate increases, and they may explain why the American economy has not cooled down more significantly so far. In fact, government money artificially stimulates demand for goods, services and workers – especially in the service sector. If you believe Kaplan’s statements, there is actually a kind of wage-price spiral going on in this sector.

This constellation can cause all sorts of surprises – perhaps even a further surge in inflation. No wonder Jerome Powell remains vigilant even in the face of record-breaking amounts of money in economic circulation. Ultimately it’s about his standing.