US, Sep 13 : The US Federal Reserve is heading into a closely watched rate-setting meeting this week, with financial markets increasingly expecting policymakers to raise interest rates as inflation remains well above the central bank’s long-term target.
The decision is likely to become an early test of Federal Reserve Chair Kevin Warsh’s credibility, particularly as the central bank faces continued political pressure from US President Donald Trump to keep borrowing costs lower and support economic growth.
The US economy has struggled with persistent inflation in recent years, while energy price shocks, tariff policies and strong investment linked to the artificial intelligence boom have added to concerns over the outlook for consumer prices.
The central bank has kept its benchmark interest rate unchanged since January as policymakers assessed the impact of higher energy costs and tariffs on the broader economy.
However, several Fed officials, including Warsh, have recently indicated that further action may be necessary if inflation fails to show convincing signs of easing.
Fresh consumer-price data released on Friday showed inflation holding at 3.4 per cent in August, unchanged from the previous month. The reading, however, remains significantly above the Federal Reserve’s 2 per cent long-term target.
Following the inflation report, expectations for a 25 basis point increase at Wednesday’s meeting strengthened sharply. According to CME Group’s FedWatch tool, markets were assigning more than an 85 per cent probability to such a move.
The Fed last increased interest rates three years ago during its aggressive campaign to contain inflation following the economic disruption caused by the COVID-19 pandemic. Its benchmark rate currently stands between 3.50 per cent and 3.75 per cent.
Political pressure adds to Fed challenge
The upcoming decision is also being closely watched because of Trump’s repeated criticism of the central bank over interest rates.
Since beginning his second term, Trump has mounted unusually strong attacks on the Fed’s independence while calling for lower rates to encourage economic activity.
The administration has also taken steps involving senior Federal Reserve officials, including launching a criminal investigation into former chair Jerome Powell and attempting to remove another governor.
Warsh, who was appointed by Trump, now faces a key decision over whether to prioritise inflation control or accommodate calls from the White House for easier monetary policy.
“This is the test. This is what comes with that job, and now he has to decide how to handle it,” said David Wessel, a senior fellow at the Brookings Institution.
He said Warsh could either disappoint financial markets or risk provoking a strong reaction from Trump if the central bank increases borrowing costs.
The Federal Open Market Committee, which has 12 voting members, is scheduled to announce its decision at 2 pm on Wednesday following a two-day policy meeting.
Rate increase could slow economic activity
Economists have warned that higher interest rates would increase borrowing costs for households and businesses, potentially slowing investment, consumption and other areas of economic activity.
Claudia Sahm, chief economist at New Century Advisors and a former Fed economist, said an increase was likely but stressed that the decision was not certain.
“It is a difficult decision for them to make,” Sahm said.
She described higher rates as a costly measure rather than an instant solution to price pressures, noting that policymakers could still decide to leave borrowing costs unchanged.
However, holding rates steady despite market expectations of an increase could create additional uncertainty unless the central bank provides a convincing explanation.
“If they surprise markets and they can’t explain why they’re surprising markets, then Wednesday afternoon will be pretty messy,” Sahm said.
Warsh’s communication strategy under scrutiny
Warsh has also introduced changes in the way the Federal Reserve communicates its policy outlook since taking office.
He has argued for reducing the level of forward guidance provided by policymakers, saying excessive transparency can limit their ability to respond when economic conditions change.
The shift has received mixed reactions from investors and analysts, with some warning that reduced guidance could make it more difficult for markets to assess the future path of monetary policy.
Warsh has previously supported lower rates on the grounds that productivity gains from artificial intelligence could strengthen the economy. More recently, however, he has placed greater emphasis on the Fed’s responsibility to bring inflation back toward its target.
For analysts, Wednesday’s decision could therefore have implications beyond the immediate interest-rate outlook.
Wessel said there had been questions over whether Warsh would follow the approach of previous Fed leaders and make decisions based primarily on economic conditions, even when those decisions were politically unpopular.
“If he raises rates now and Trump goes ballistic, he will have established his credibility as an independent Fed chair for the rest of his term,” Wessel said.