Fed forecasts higher interest rates, slower growth ahead

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economic forecast

While the big news coming out of the recent meeting of the Federal Open Market Committee (FOMC) was their decision to raise the Fed Funds rate by another half point, the Federal Reserve also released updated forecasts for other key economic metrics at that meeting.

The forecasts see higher inflation in the near term which will require higher interest rates, a bigger rise in unemployment and a bigger drop in GDP over the next few years in order to bring it under control.

The FOMC meets 8 times per year but only releases economic forecasts at 4 of the meetings. The Fed forecasts present estimates for economic metrics by year through 2025 and a “longer run” forecast which reflects their view of the output of the economy if operating at equilibrium. The consensus Fed forecast is developed by the combining the forecasts of 18 economists. Each of the economists assumes that the Fed will follow “appropriate” monetary policy during the term of the forecast, although their individual ideas of what that policy is may vary.

Interest rates going up

The headline news coming out of the recent Fed meeting was their announcement of another 0.5 percent interest rate hike. The Fed expects the Fed Funds rate to close 2022 at 4.4 percent, unchanged from their September forecast. However, the forecast for the Fed Funds rate was raised from 4.6 percent to 5.1 percent to close 2023 and from 3.9 percent to 4.1 percent for 2024. A history of the forecasts for the Fed Funds rate is given in the first chart, below.

fed funds rate forecast interest rate forecast

GDP: slowdown expected

Fed’s current forecast for GDP growth in 2022 was raised to 0.5 percent, up from the 0.2 percent they forecast in September. However. the Fed lowered its GDP forecasts for 2023 from the 1.2 percent predicted in their September forecast to only 0.5 percent. The Fed made a 0.2 percentage point reduction to their GDP forecast for 2024 but left their forecasts for 2025 and beyond unchanged. Recent Fed GDP forecasts are illustrated in the next chart, below.

GDP growth forecast

Inflation outlook worsens

The Federal Reserve’s preferred inflation measure is based on the Personal Consumption Expenditures (PCE) survey, rather than the more familiar Consumer Price Index (CPI). The history of the Fed’s recent PCE inflation forecasts is shown in the next chart. The Fed now expects year-end inflation in 2022 to come in at 5.6 percent, up from their September forecast of 5.4 percent. PCE inflation is forecast to be 3.1 percent in 2023, up from the 2.8 percent forecast in September. PCE inflation is expected to be 2.5 percent in 2024 and 2.1 percent in 2025. The Federal Reserve’s target for PCE inflation is 2.0 percent.

PCE inflation forecast

Unemployment forecasts higher

The current Q4 2022 unemployment rate is forecast to be 3.7 percent, down 0.1 percentage point from the September forecast. The Fed forecasts that unemployment will rise to 4.6 percent in Q4 2023, up 0.2 percentage points from their last forecast. The Q4 unemployment rates are forecast to be 4.6 percent in 2024 and 4.5 percent in 2025.

unemployment rate forecast

The next updates to the Federal Reserve’s forecasts for the economy will come after the March 2023 FOMC meeting.