Federal Reserve 'still has work to do' on inflation, opts for slow policy easing, Fitch says

The US Federal Reserve's easing cycle will be “lighter” by historical standards when it starts cutting rates at its September policy meeting, ratings agency Fitch said in a note.

In its Global Economic Outlook report for September, Fitch forecast a 25-basis-point cut each at the central bank's September and December meetings, before it cuts rates by 125 basis points in 2025 and 75 basis points in 2026.

That would add a total of 250 basis points in 10 moves over 25 months, Fitch noted, noting that the average downward cut from the peak rate in previous Fed easing cycles through the mid-1950s was 470 basis points, with an average duration of 8 months.

“One reason we expect Fed easing to proceed at a relatively gentle pace is that there is still work to be done on inflation,” the report said.

This is because CPI inflation is still above the Fed's set inflation target of 2%.

Fitch also noted that the recent decline in core inflation — which excludes food and energy prices — rates mostly reflects a decline in automobile prices, which may not last.

U.S. inflation fell to the lowest level since February 2021 in August, the Labor Department reported on Wednesday.

The consumer price index rose 2.5% year-over-year in August, less than the 2.6% expected by the Dow Jones and hitting the slowest growth rate in 3½ years. On a month-on-month basis, inflation rose 0.2% from July.

Core CPI, which excludes volatile food and energy prices, rose 0.3% for the month, slightly above estimates of 0.2%. The 12-month core inflation rate was kept at 3.2%, in line with forecasts.

Fitch also noted that “inflation challenges faced by the Fed over the past three-and-a-half years are also likely to raise caution among FOMC members. Controlling inflation has taken longer than expected and gaps have emerged in central banks' understanding of what drives inflation.”

In Asia, Fitch expects rate cuts in China to continue, noting that the People's Bank of China's rate cut in July surprised market participants. The PBOC cut the 1-year MLF rate to 2.3% from 2.5% in July.

“[Expected] Fed rate cuts and recent weakness in the US dollar have opened up some room for the PBOC to cut rates further,” the report said, adding that inflationary pressures are seeping into China.

Fitch noted that “producer prices, export prices and home prices are all falling and bond yields are falling. Core CPI inflation has eased to just 0.3% and we have cut our CPI forecast.”

It now expects China's inflation rate to settle at 0.5% in 2024, down from 0.8% in its June outlook report.

The rating agency forecasts an additional 10 basis points cut in 2024 and another 20 basis points cut in 2025 for China.

On the other hand, Fitch noted that “The [Bank of Japan] The global trend and increased rate of policy easing more aggressively than we expected in July. This reflects his growing conviction that reflation is now firmly entrenched.”

With 23 straight core inflation above the BOJ's target and companies “ongoing” and set to pay “substantial” wages, Fitch said the situation was quite different from the “lost decade” of the 1990s when wages failed to rise amid persistent inflation. .

That plays into the BOJ's goal of a “good wage-price cycle” — which boosts the BOJ's confidence that it can raise rates toward neutral settings.

Fitch expects the BOJ's benchmark policy rate to reach 0.5% in late 2024 and 0.75% in 2025, adding “We expect the policy rate to reach 1% by the end of 2026, above consensus. More The dire BOJ could go global.”