The Federal Reserve raised its benchmark interest-rate target by a quarter percentage point this week to 5.25%–5.50%, the highest range in more than two decades, while signaling that future decisions will depend on whether inflation continues to cool without a sharp deterioration in employment or growth. The July 26 statement was unanimous and resumed tightening after policymakers held rates unchanged in June.

The increase brings the cumulative rise in the federal funds target to 5.25 percentage points since March 2022. It also comes as incoming data are finally showing a meaningful slowdown in inflation. The Bureau of Economic Analysis reported Friday that the Federal Reserve’s preferred personal consumption expenditures price index rose 3.0% over the 12 months through June, while the core measure excluding food and energy rose 4.1%.

The Fed resumed tightening after a one-meeting pause

The central bank’s implementation note directs the New York Fed to maintain the federal funds rate in the new 5.25%–5.50% range and raises the interest paid on reserve balances to 5.4%. It also preserves the balance-sheet runoff program, with monthly redemption caps of $60 billion for Treasury securities and $35 billion for agency mortgage-backed securities.

Officials are trying to distinguish a slower pace of policy adjustment from an end to the tightening cycle. The July statement says inflation remains elevated and that the committee will assess “additional information and its implications for monetary policy.” It repeats the commitment to return inflation to the 2% objective but avoids promising another increase at the September meeting.

The June Summary of Economic Projections showed why policymakers are reluctant to declare the job finished. The median participant projected a federal funds rate of 5.6% at the end of 2023, implying that most officials expected at least some additional tightening beyond the 5.1% median they had projected in March.

Inflation is falling, but core services remain the problem

The latest PCE report provides the strongest evidence yet that price pressures are moderating. Overall PCE inflation fell to 3.0% from a year earlier, while core PCE slowed to 4.1%. On a monthly basis, both overall and core prices rose 0.2%. Goods prices were 0.6% lower than a year earlier, but services prices remained 4.9% higher.

That pattern closely follows the Labor Department’s June consumer-price report, which showed headline CPI inflation at 3.0% and core inflation at 4.8%. Energy prices were sharply lower from a year earlier, while shelter continued to make an outsized contribution to underlying inflation.

The distinction matters for monetary policy. Lower gasoline, commodity and goods prices can pull headline inflation down quickly, but service-sector inflation is more closely connected to wages, rents and domestic demand. The Fed is looking for evidence that those pressures are easing enough to make the decline in inflation sustainable.

Wage growth is moderating without collapsing

The Labor Department’s second-quarter Employment Cost Index, released Friday, showed compensation costs for civilian workers rising 1.0% during the quarter and 4.5% over 12 months. Wages and salaries rose 4.6% from a year earlier. Those gains remain faster than the pace consistent with 2% inflation over time, but they are below the most intense wage pressures seen earlier in the recovery.

The labor market also remains historically strong. The June employment report showed payroll employment increasing by 209,000 and unemployment at 3.6%. Average hourly earnings were 4.4% higher than a year earlier. The combination of steady hiring and slowing inflation is giving policymakers more room to judge each meeting on new data rather than following a predetermined sequence of rate increases.

For households and businesses, however, the accumulated effect of higher interest rates is becoming increasingly visible. Mortgage rates remain elevated, bank lending standards have tightened, and financing for autos, credit cards and business investment is significantly more expensive than it was before the Fed began tightening.

The September decision is deliberately open

The Fed’s challenge now is asymmetric. Raising rates too little could allow inflation to stabilize above target or reaccelerate; raising them too far could turn a gradual slowdown into a recession after the effects of earlier increases arrive with a lag. The July statement explicitly cites cumulative tightening and the delayed transmission of monetary policy as factors officials will consider.

Recent data strengthen the case for patience. Real consumer spending increased 0.4% in June, according to BEA, while real disposable personal income rose 0.2%. Inflation is falling at the same time, and the unemployment rate remains below 4%. That is the configuration policymakers have been seeking, but core inflation still runs at roughly twice the formal target.

The July increase therefore looks less like the beginning of another rapid sequence than an effort to preserve pressure on inflation while the Fed waits for confirmation. At 5.25%–5.50%, monetary policy is now clearly restrictive. Whether it becomes more restrictive will depend on what the next several weeks reveal about prices, wages, hiring and credit conditions.