Rising interest rates have only moderately dented inflation so far and may need to move significantly higher, according to Morgan Stanley. Falling gasoline prices over the past two months have helped keep top-line inflation under control. But that trend has masked the rises in the cost of living that have spread to other areas. For example, food prices in the consumer price index have risen by 1.9% in the past two months, while the cost of shelter, which accounts for about a third of the CPI, has increased by 1.2% over the same period. General inflation, including food and energy prices, is still 8.3% higher year on year, while core inflation — excluding food and energy — is up 6.3%, including a much higher-than-expected monthly increase of 0.6 % in August. The inability to curb inflation on a broad scale could make policymakers impatient and also drive longer-term interest rates higher, Ellen Zentner, Morgan Stanley’s chief US economist, said in a client note Friday. “The real economy today may be less sensitive to higher rates, meaning the level of interest rates needed to slow the economy will likely be higher as well,” Zentner said. “Coming fast can be costly.” Markets expect the Fed to make a third consecutive rate hike of 0.75 percentage point on Wednesday and another hike of that magnitude at its next meeting in November, with pricing leaning toward a half-point move in December, according to the CME Group. . Current market prices in fed funds futures indicate that the Fed’s “final interest rate,” or the point at which the Fed stops rate hikes, will reach 4.39% in April 2023. final rate of 4.25% -4.5%. According to the rate-setting Federal Open Market Committee forecast in June, the final rate was expected to rise to 3.8% in 2023, meaning current market prices are about half a percentage point higher than those forecasts. But Zentner thinks the central bank may need to go even further to tackle inflation. The Cleveland Fed’s measure of “sticky price” inflation of goods whose prices generally don’t fluctuate much continues to rise, rising from 6.1% in August at 12 months and 7.7% at one month on annual basis. Zentner isn’t alone in that sentiment either. Citigroup economist Andrew Hollenhorst also sees an upside risk for fund rates. “Despite the dramatic upward revisions to key rate projections, risks remain on the upside: it is much easier to see scenarios where key rates go above 5% than when the cycle ends below 4%,” he said in a note from Sunday. According to data from the Fed, interest rates have not risen above 5% since August 2007. Those expectations for higher rates are causing Wall Street economists to rethink their growth forecasts. In the near term, Zentner lowered its third-quarter GDP outlook from 1% to 0.8%. That ties in with the Atlanta Fed’s GDPNow tracker, which in last week’s latest update now points to growth of just 0.5% in the third quarter. Goldman Sachs has also raised its expectations for rate hikes this year, although it still sees a terminal rate between 4% and 4.25%. However, the bank lowered its GDP forecast for 2023 from 1.5% to 1.1%. As long as the job market remains strong and the economy doesn’t slide into a deep recession, the Fed will likely continue to raise interest rates until it sees real progress on inflation, Zentner said. “So far, higher interest rates have done little widespread harm to the real economy, so the Fed has room to move into restrictive territory,” the Morgan Stanley economist said. “Basically, the Fed needs more evidence that its actions are taking a bite out of the real economy.”

With inflation still high, the Fed may be a long way from stopping rate hikes