Federal Reserve projects one rate cut this year, sees limited economic impact from Iran war

Federal Reserve Chair Jerome Powell speaks at the Federal Reserve in Washington. (AP Photo/Jacquelyn Martin, File)

WASHINGTON — Federal Reserve officials expect the Iran war will worsen inflation this year while having little impact on economic growth, but they still expect to cut their key rate once in 2026.

For now, Fed policymakers left short-term interest rates unchanged Wednesday for the second straight meeting at about 3.6 per cent. In a statement, the central bank said that the “implications of developments in the Middle East for the U.S. economy are uncertain.”

Still, by keeping their forecast for a rate cut this year and next -- the same projections that they made in December -- central bank policymakers appear to expect the gas price spike from the Iran war to have a largely temporary effect on inflation and the economy. Policymakers also foresee unemployment remaining unchanged by the end of this year, a more optimistic outlook than most outside economists.

Whether that turns out to be true will largely depend on the length of the conflict in the Middle East. The officials expect inflation to fall back to 2.2 per cent in 2027 and hit the Fed’s two per cent target in 2028.

Speaking to reporters after the rate decision was announced, Powell said that in the short-term, higher oil and gas prices will elevate inflation, but it is too soon to know the potential impacts on the economy.

“The U.S. economy is doing pretty well, it’s just we don’t know what the effects of this will be, and really no one does,” Powell said.

In their economic projections, Fed officials now forecast that inflation will be 2.7 per cent at the end of this year, up from their December forecast but slightly below the 2.8 per cent it reached in January. They expect core inflation, which excludes the volatile food and energy categories, to also finish the year at 2.7 per cent, up from a previous forecast of 2.5 per cent. The Fed considers core prices a better measure of longer-run inflation. Consumer prices will spike higher in the coming months as gas prices have soared, but those increases could unwind by the end of the year, particularly if the conflict ends soon.

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The Fed also expects that the war will have no sustained impact on growth or unemployment. Officials still see the unemployment rate at 4.4 per cent at the end of this year, the same as it is now. And they project the economy will grow 2.4 per cent this year, up slightly from a 2.3 per cent forecast in December.

One Fed official, governor Stephen Miran, dissented in favor of a quarter-point cut. Miran was appointed by President Donald Trump last September.

Gas prices jumped Wednesday to a nationwide average of $3.84 a gallon, according to AAA, up 92 cents from a month ago. The increase will push inflation much higher in March, but core inflation, since it excludes gas, could be much less affected.

Typically, the Fed would look past a supply shock like the disruption in oil supplies from the Middle East and its impact on inflation. Once it ends, any inflation it produces may fall back, without the Fed having to raise rates. As a result, the Fed could leave rates unchanged -- or even cut them to boost weak hiring.

Yet as the economy emerged from the pandemic in 2021, inflation jumped as Americans sharply raised their spending, aided by stimulus checks and pandemic-era savings. Powell initially said that inflation would be “transitory” and would fade as the economy returned to normal. Instead it spiked to a four-decade high in June 2022. With inflation still elevated, many Fed officials are wary of repeating the mistake.

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This week’s meeting will be among the last with Powell as chair. His term ends May 15 and President Donald Trump has nominated a former top Fed official, Kevin Warsh, to replace him. Yet Warsh’s nomination has been delayed in the Senate because key Republican senators have objected to a Justice Department investigation of Powell over his testimony about a building renovation.

Last Friday, a judge threw out a pair of subpoenas that the Justice Department had issued to the Fed, dealing a blow to the investigation. But U.S. Attorney Jeannine Pirro has said she will appeal the ruling.

This week’s meeting will be Powell’s second-to-last, unless Warsh isn’t confirmed by May 15, at which point Powell could remain chair of the Fed’s rate-setting committee until a replacement is named.

Even before the Iran war, problems had cropped up in both the inflation and jobs data, putting the Fed in a tight spot. Prices rose more quickly in January than in recent months, according to the Fed’s preferred measure, with inflation excluding food and energy reaching 3.1 per cent compared with a year earlier. That is little changed from where it was two years ago, a sign that prices are still rising at a stubbornly elevated pace.

et hiring has also stumbled. Businesses and other employers shed 92,000 jobs in February, the government reported earlier this month, an unexpectedly weak showing that followed an encouraging gain of 130,000 in January. The unemployment rate ticked higher to a still-low 4.4 per cent from 4.3 per cent.

Christopher Rugaber, The Associated Press