The Federal Reserve on Wednesday raised its benchmark policy rate by half a percentage point and signalled its intention to keep squeezing the US economy next year, as central banks on both sides of the Atlantic enter a new phase in the battle against inflation.

At its final gathering of the year, the Federal Open Market Committee voted unanimously to increase the federal funds rate to a target range of 4.25 per cent to 4.5 per cent, ending a months-long string of 0.75 percentage point rate rises.

The pivot to smaller rate rises is likely to be followed internationally, with the European Central Bank and the Bank of England both poised to increase borrowing costs by half a percentage point on Thursday.

Economists say that inflation has peaked in all three regions, with reductions in the headline rate in the US and UK this week, but central banks remain worried that it will take too long to fall towards their 2 per cent targets.

In a press conference following the decision, Fed chair Jay Powell said: “We’ve covered a lot of ground and the full effects of our rapid tightening so far are yet to be felt. We have more work to do.”

Powell welcomed the reduction in headline price growth in October and November but warned “it will take substantially more evidence to give confidence that inflation is on a sustained downward path”.

In its statement the Fed said that “ongoing increases” in the policy rate would be “appropriate” in order to ensure it is restraining the economy enough to bring price growth under control.

As Powell spoke at his press conference, US stocks fell to session lows, with the S&P 500 down 0.8 per cent and the Nasdaq Composite 1 per cent lower. The two-year Treasury yield, which moves with interest rate expectations, was up 0.03 percentage points to 4.2 per cent.

Jay Barry, co-head of US rates strategy at JPMorgan, said that ahead of the decision investors had debated whether the Fed would drop the “ongoing increases” language in favour of something more dovish.

Sticking with phraseology “suggests we’re multiple meetings away from the tightening cycle being done”, Barry added.

Alongside the rate decision, the Fed published a revised “dot plot” of officials’ individual interest rate projections, which indicated support for further tightening next year.

The median estimate for the fed funds rate by the end of 2023 rose to 5.1 per cent, up from the 4.6 per cent peak forecasted the last time projections were published in September. That suggests a total of 0.75 points’ worth of rate rises still to come.

Most officials now see the policy rate declining to 4.1 per cent in 2024 and 3.1 per cent in 2025. That compares to 3.9 per cent and 2.9 per cent, respectively, three months ago.

However, Powell noted that Fed officials had consistently increased their forecasts for peak interest rates and warned: “I can’t tell you confidently that we won’t move up our estimate . . . again.”

Policymakers increased their forecast for inflation next year, with the median estimate for the core personal consumption expenditures price index — their preferred inflation gauge — rising to 3.5 per cent, compared to 3.1 per cent in September.

In 2024, most officials anticipate it will have only declined to 2.5 per cent, still above the central bank’s target. It is forecast to decline to 2.1 per cent the following year.

Reflecting officials’ expectations that they will need to squeeze the economy more than previously expected, policymakers were more downbeat on the outlook. The economy is set to grow by just 0.5 per cent in 2023 before registering a 1.6 per cent expansion in 2024 as the unemployment rate tops out at 4.6 per cent.

In September, most officials predicted economic growth of 1.2 per cent for 2023 followed by a 1.7 per cent increase in 2024, with the unemployment rate topping out at 4.4 per cent.

The December meeting marks an important juncture for the Fed, which this year embarked on the most aggressive attempt to tighten monetary policy since the early 1980s. As the central bank’s actions have begun to have a noticeable impact on the economy, a debate has emerged about how much more restraint is needed to tame inflationary pressures that remain elevated in many sectors.

Powell has previously said it will take “substantially more evidence” than a single month’s data for the central bank to be confident inflation is actually declining, noting past periods when better than expected data were followed by fresh increases.

US home prices have fallen from their recent peak as mortgage rates have surged, the manufacturing sector is flagging and consumer sentiment remains low.

However, the labour market continues to show resilience. The unemployment rate still hovers at a historically low level of 3.7 per cent and wages have risen rapidly amid an acute worker shortage, accelerating to a pace officials warn risks igniting yet more price pressures.

Powell recently said it was “very plausible” that the Fed could bring down inflation without causing a recession. New polling conducted by the Financial Times suggests doubts about that outcome, however. Of the economists surveyed, 85 per cent expect a recession next year.