By Christopher Lugerber, Economics writer for the Associated Press
WASHINGTON (AP) — Things looked pretty good when Federal Reserve officials last met in late January. Employment was solid. The economy had just grown at a solid pace in the final quarter of last year. Inflation, stubbornly, had fallen sharply from its peak over two years ago.
What is the difference between the seven weeks?
As the Fed prepares to meet on Tuesday and Wednesday, the central bank and its chairman Jerome Powell could head to a much tougher place. Inflation improved last month, but it is still high and tariffs could push it high. At the same time, the ongoing tariff threat and rapid government spending and employment cuts have thwarted consumers and business trust, strained the economy and even boosted unemployment.
The toxic combination of still high inflation and a weak or stagnant economy is often referred to as “stagflation,” a term that plagues central bankers. That was what baffled the US in the 1970s when even a deep recession didn’t kill inflation.
When stagflation appears, it is usually difficult for the Fed as policymakers can raise rates or keep them high to combat inflation. However, if unemployment rates also rise, the Fed will usually cut borrowing costs and cut fees to lift growth.
It is not yet clear that the economy will sink into the stag. For now, like businesses and consumers, the Fed is tackling the enormous amount of uncertainty surrounding the economic outlook. But even the milder version has seen unemployment rise from the current low level of 4.1%, while inflation remains above the Fed’s 2% target, a challenge for central banks.
“It’s the intertwined web they’re on,” said Esther George, former president of the Kansas City branch of the Federal Reserve. “On the one hand, there’s the stickiness of inflation. At the same time, we’re trying to see how this will affect the job market if growth starts to pull back. So that’s certainly a difficult scenario for them.”
Fed officials will almost certainly not change important rates at this week’s meeting. When the meeting closes on Wednesday, they will release their latest quarterly economic forecasts.
The Fed implemented three cuts last year, signaling its meeting in January that it was primarily suspended until the economic outlook became clearer.
Wall Street investors are hoping to cut the rate three times this June, September and December, according to futures prices tracked by CME FedWatch.
One development that could destabilise Fed officials is the rapid jump in inflation expectations this month in the University of Michigan Consumer Sentiment Survey. It has shown the biggest increase in long-term inflation expectations since 1993.
Such expectations that fundamentally measure whether Americans are concerned about inflation are important because they can be self-fulfilling. If businesses and consumers expect higher costs, they can take measures to boost inflation, such as demanding higher wages.
Some economists note that the University of Michigan survey is preliminary and is based on around 400 responses so far. (The final version released later this month will typically include around 800.) and financial market measurements of inflation forecasts based on bond prices have actually declined in recent weeks.
The latest inflation measurements are mixed. The consumer price index fell for the first time last week from 3% to 2.8% for the first time in five months. This is an encouraging change. However, the Fed’s preferred pricing meter, which will be released later this month, may not have changed.
The jump to inflation expectations is also a problem for the Fed, as officials, including Powell, say they are willing to gradually return to their 2% target in 2027, as expectations were generally low. If other measures indicate an uptick inflation concern, the Fed may be under more pressure to reduce inflation more quickly.
“I’m worried when I see consumer expectations moving in the opposite direction,” George said. “I think you have to keep an eye on that.”
The last time President Donald Trump imposed tariffs was in 2018 and 2019 when overall inflation rates didn’t rise much. This is because it is not as broad as what he currently proposes, and the duty of steel and aluminum has been watered down by loopholes. Now that Americans have gone through painful inflationary episodes, they could be thinner about price increases.
Powell mentioned such concerns in his remarks earlier this month. He said tariffs could have a one-off effect on prices without causing continued inflation. But it said, “If it turns into a series tariff hike, on March 7, or “If the increase is big, that’s important.”
“What really matters is what’s going on with long-term inflation expectations,” Powell added.
A week after his comments, these expectations shined high in the University of Michigan survey.
Original release: March 17, 2025 9:01am EDT
