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Fed to hold rates until at least July; first cut not start of stimulus wave: Reuters poll

FILE PHOTO: Federal Reserve Board Building in Washington

By Prerana Bhat and Indradip Ghosh

BENGALURU (Reuters) - The U.S. Federal Reserve will hold interest rates until at least July, later than earlier thought, according to a slim majority of economists in a Reuters poll who said the first cut would be to adjust the real rate of interest, not the start of stimulus.

All but five of 102 economists in the Dec. 1-6 Reuters poll said the Fed was done hiking in this cycle, even though Chair Jerome Powell said last week policymakers were "prepared to tighten policy further if it becomes appropriate to do so".

The debate has now shifted to how long the federal funds rate will remain in its current 5.25%-5.50% range and how many cuts will be delivered next year, which the survey suggests will be significantly less than what markets are currently expecting.

Despite recent strong economic growth and inflation running above target, markets are pricing in around 150 basis points of cuts next year, starting in March, a swift change from the "higher for longer" narrative just a few weeks ago.

Economists are less convinced the Fed will start cutting so soon, with slightly more than half, 52 of 102, forecasting no rate cuts until at least July. Nearly three-quarters of forecasters, 72 of 102, predicted 100 basis points of cuts or less next year.

The proportion of Fed watchers expecting a cut sometime in the first six months of the year is moving in the opposite direction to markets and has steadily dropped in recent months from more than 70% in September.

"We agree the Fed will cut in 2024, but think markets are underestimating how stubbornly high inflation will delay cuts until activity has more clearly slowed," said Andrew Hollenhorst, chief U.S. economist at Citi.

Markets have moved sharply. Benchmark 10-year Treasury note yields have dropped sharply in the past month, after crossing 5% in October. The S&P 500 is up over 19% for the year, marking its best month since July 2022 in November.

"We expect stronger core ... inflation in coming months to disrupt the slowing-inflation narrative," said Hollenhorst, who expects the Federal Open Market Committee to start cutting in the third quarter of next year.

"And even if we are wrong and inflation stays softer, so long as activity holds up, the committee might take the opportunity to bolster their credibility by waiting for even stronger evidence that inflation had sustainably slowed."

All inflation measures polled by Reuters - the consumer price index (CPI), core CPI, PCE and core PCE - were predicted to decline gradually but remain above the central bank's 2% PCE target until at least 2025.

Still, the interest rate adjusted for inflation - the real rate - would become more restrictive if left unchanged as price pressures fall and poses a risk of slowing the economy too much.

Over two-thirds of respondents, 26 of 38, who answered an additional question said adjusting that real rate down would prompt the first Fed rate cut, rather than a need to shift towards stimulating the economy.

The world's No. 1 economy, after growing at a strong 5.2% annualized pace last quarter, was expected to lose momentum and expand 1.2% this quarter and average 1.2% in 2024.

Still, the economy has held up well against the 525 basis points of hikes in the most aggressive tightening cycle in four decades and was expected to continue to add thousands of jobs, keeping the unemployment rate low and price pressures high.

"With the current stance of policy 'becoming more balanced', the courage for the Fed to remain on hold will be challenged," said Ellen Zentner, chief U.S. economist at Morgan Stanley who cautioned not to call next year's moves an easing cycle.

"When the Fed begins to cut rates in 2024, it is maintaining a certain level of restrictiveness by following inflation downward ... Cutting versus easing is not just semantics, it's an important distinction."

(For other stories from the Reuters global economic poll:)

(Reporting by Prerana Bhat and Indradip Ghosh; Polling by Purujit Arun; Editing by Ross Finley and Nick Zieminski)