Fed Officials See Need for Continued Interest-Rate Increases, but Less Certainty Over Destination

Federal Reserve officials agreed at their meeting last month they needed to keep raising interest rates enough to slow the economy and likely would need to hold rates at that level until it was clear inflation was decelerating.

Officials voted to raise their benchmark rate by 0.75 percentage point in July, following an increase of the same size in June. Those were the largest rate increases since 1994. Several officials have indicated since the meeting that they would support lifting rates by at least a half percentage point at their next meeting in September.

Officials last month signaled sensitivity to two different risks–that they might not raise rates enough to bring down inflation and that they might raise borrowing costs more than needed, causing unwarranted economic weakness, according to minutes from the Fed’s July 26-27 meeting, released Wednesday.

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“Participants judged that, as the stance of monetary policy tightened further, it likely would become appropriate at some point to slow the pace of policy rate increases while assessing the effects of cumulative policy adjustments on economic activity and inflation,” the minutes said.

The minutes said some officials “indicated that, once the policy rate had reached a sufficiently restrictive level, it likely would be appropriate to maintain that level for some time to ensure that inflation was firmly on a path back to 2%.”

The Fed’s rate increase last month lifted its benchmark federal-funds rate to a range between 2.25% and 2.5%, but markets rallied in the hours and days after the meeting because Fed Chairman Jerome Powell offered fewer specifics about the magnitude of coming rate rises and hinted at an eventual deceleration.

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Mr. Powell described 0.75-percentage-point rate rises as “unusually large” and appeared to endorse projections made in June that showed rates rising by another percentage point through December, implying a slowdown in the pace of increases later this year.

He also said the effect of rate increases hadn’t been fully reflected through the economy, offering another reason to slow the pace of rate increases.

The minutes said officials saw a significant risk that “elevated inflation could become entrenched if the public began to question” the Fed’s resolve to raise rates high enough to slow down inflation.

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But it also showed officials for the first time this year acknowledging the risks of overdoing rate rises. “Many participants remarked that, in view of the constantly changing nature of the economic environment and the existence of long and variable lags in monetary policy’s effect on the economy, there was also a risk that the Committee could tighten the stance of policy by more than necessary to restore price stability,” the minutes said.

A recent market rally risks undoing some of the Fed’s work this summer if it results in lower borrowing costs—for example, on 30-year mortgage rates or five-year corporate bonds. Interest rates on the average 30-year fixed mortgage fell to 5.45% last week, down from 5.82% four weeks earlier, the Mortgage Bankers Association reported Wednesday.

The Fed is raising rates to combat inflation by slowing the economy through tighter financial conditions, which typically curb investment, hiring and spending. Any easing in financial conditions, if sustained, could work against the central bank’s efforts.

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In the days since last month’s meeting, Fed officials have fanned out to pour cold water on investors’ hopes that the central bank would turn from raising rates to cutting them within a year or so.

“There’s a disconnect between me and the markets,” Minneapolis Fed President Neel Kashkari said last week. Any expectation of Fed rate cuts over the next six to nine months “is not realistic.”

Instead, it is more likely the Fed will “raise rates to some point, and then we will sit there until we get convinced that inflation is well on its way back down to 2% before I would think about easing back on interest rates,” he said.

While the Fed said it would wait for evidence inflation is decelerating toward its 2% goal before halting rate increases, investors often try to anticipate such shifts before they occur. The Fed doesn’t appear to have much confidence in its own ability to forecast inflation, which makes it difficult to know when to stop raising rates.