Fed seen stopping rate hikes shy of 5% as inflation slows

© Reuters. U.S. dollar banknotes are displayed in this illustration taken, February 14, 2022. REUTERS/Dado Ruvic/Illustration

By Ann Saphir

(Reuters) -Easing inflation will allow the Federal Reserve to deliver just a quarter-point rise in interest rates at its next meeting, and to ultimately stop raising rates before they get to 5%, traders bet on Thursday.

After the U.S. Labor Department reported consumer prices fell in December from November, and Philadelphia Fed President Patrick Harker said quarter-point interest rate hikes would now be appropriate, traders of short-term interest-rate futures ramped up bets on a slower, shallower path of policy tightening ahead.

Fed funds futures prices now reflect about a 95% probability that the U.S. central bank will raise the target range for its policy rate to 4.5%-4.75%, from a current range of 4.25%-4.5%, at its meeting Jan. 31-Feb. 1.

The policy rate is seen topping out in the 4.75%-5% range, with the Fed reversing course to cut rates in the second half of the year, based on futures pricing.

Last year most of the Fed's rate hikes were in 75-basis-point increments as central bankers sought to tighten policy quickly to bring down 40-year-high inflation.

Thursday's data showed consumer prices rose 6.5% in the 12 months through December, still far higher than the Fed's 2% target but the slowest pace in more than a year and a signal that inflation is moving in the right direction, analysts said.

"Disinflation is gaining momentum as we enter 2023,giving the ‘all clear’ for the Fed to ease off the rapid pace of monetary policy tightening," wrote EY Parthenon chief economist Gregory Daco. "We remain of the opinion that the Fed will only raise rates twice by 25 basis points in early 2023 and that it will pause its tightening cycle at 4.75-5.00%."