Raising interest rates to deliberately slow the U.S. economy isn’t a job for the faint of heart, but the next test for the Federal Reserve could make even that challenging task look simple.

After lifting interest rates last year at a pace not seen since the last time inflation soared this much 40 years ago, Fed officials will soon have to decide when it’s time to stop making it more expensive to borrow money. The result could have grave implications for Americans’ purchasing power, the job market and the U.S. economy.

A pause in hiking rates isn’t yet around the corner, but the debate about when to stop could be picking up soon. Officials in February raised rates by a quarter of a percentage point, the smallest rate hike since last March and a downshift from the massive half-point and three-quarter-point increases the Fed stuck with for six straight meetings.

Like an airplane leveling off once it hits its cruising altitude, officials think interest rates will eventually reach a level high enough that, with time, will start to curb demand and suppress inflation. Only since September have interest rates hit a level thought to restrict economic growth, and monetary policy can often take months, if not a year, to spread throughout the economy. Pulling back soon could also help the Fed avoid tightening rates too much, hurting Americans’ job prospects and further squeezing people’s buying power.

But the Fed could just as easily find it has done too little. Pulling back on rate hikes too soon risks keeping inflation elevated, meaning any Fed pause could be short-lived. Fed Chair Jerome Powell himself admitted not doing enough is far riskier, adding they can fix doing too much easier than doing too little.

“The hard work is still ahead,” says Greg McBride, CFA, Bankrate chief financial analyst. “The benchmark fed funds rate is at 2007 levels and it may not be coming back down nearly as soon as investors seem to think.”

When will the Fed stop hiking rates? Watch for rates to hit this level

Most economists say the Fed will likely stop raising interest rates at some point in 2023, but “where” rates peak — a level known as the “terminal” rate — is actually more important than “when.”

While the Fed is starting to raise rates in smaller amounts, what’s clear is the Fed isn’t done raising rates yet. The median projection among Fed officials put interest rates in a final target range of 5-5.25 percent, suggesting the Fed will likely raise interest rates another 50 basis points before it backs down.

“We have more work to do,” Powell said at the Fed’s February post-meeting press conference, referring to more rate hikes. “We’re going to be cautious about declaring victory and sending signals that we think the game is won.”

Fed officials update their rate projections every quarter and have upgraded all of them this year. Officials in September, for example, thought they’d hit a terminal rate of 4.5-4.75 percent in 2023. That was 75 basis points higher than their June projection and a whopping 175 basis points above their March forecast.

The difficulty with forecasting is, the U.S. economy — and inflation — hasn’t evolved as officials expect. Back in March, the Fed only saw prices in 2022 rising 4.3 percent from a year ago. As of October, however, they’re up 6 percent.

“Powell can do one of two things: Step on the gas or step on the brake,” says Robert Barbera, director of the Center for Financial Economics at Johns Hopkins University. “Except you can’t see in front of you because the windshield is covered in black paint; the only thing you can do is look in the rearview mirror. You’re stepping on the gas or the brake as a consequence of what you know was happening, rather than what you know will be happening.”

But deciding when to stop raising rates is also a difficult task when each Fed official has a different view on when enough is actually enough. The U.S. central bank can’t approve a rate hike without a majority vote.

A substantial group of Fed officials in December revealed they saw rates rising even higher than the median 5-5.25 percent. Five policymakers, for example, penciled in rates at 5.25-5.5 percent by the end of 2023, calling for another full percentage point of rate hikes. Another two officials saw rates reaching a 22-year high of 5.5-5.75 percent, meaning an extra 1.25 percentage points of rate hikes from here would be necessary.

Bankrate’s McBride saw rates hitting 5.25-5.5 percent by the time 2023 comes to a close, according to his 2023 interest rate forecast.

Hotter-than-expected inflation could knock the Fed’s plans off course

The path the Fed takes depends on inflation.

Powell has been clear about policymakers’ North Star: Getting inflation down to their 2 percent target.

“Without stable prices, we can’t have maximum employment,” Powell said at a Nov. 30 event at the Brookings Institution. “The world will be better off if we can get this over with quickly.”

The inflation picture, however, is quickly evolving. Improving supply chains and falling energy prices have helped take some of the edges off of surging gasoline, vehicle and electronics prices. Yet, food inflation has only modestly cooled from its 43-year high of 13.5 percent in August, rising 11.8 percent in December from a year ago, according to the Department of Labor.

Inflation is also impacting housing. Rents jumped 8.3 percent from a year ago for three straight months, the biggest price burst in 40 years, as leases surge from their coronavirus pandemic-era lows.

Yet, that’s not what Powell and the Fed are most worried about. Services — from health care and restaurant visits to haircuts — are also surging, rising 7 percent from a year ago, another jump that hasn’t occurred since 1982.

Those price increases have more to do with a labor market that’s remained red-hot despite 4.25 percentage points of Fed tightening. Employers still have about 1.9 open jobs per every unemployed worker, a near record mismatch between labor demand and supply.

To lure more talent, employers are lifting wages at the fastest pace in more than two decades — but it risks repeating a vicious cycle if firms pass along those higher prices to consumers by lifting up their products. Consumers may start to approach their employers for raises as well. Foreshadowing improvement, wage growth is cooling, but it could take time for price increases to settle back toward a level more manageable for consumers.

A worse-case scenario, this pattern could make inflation even more stubborn than it is now, and if the Fed doesn’t cool the economy enough with higher rates, U.S. central bankers see it as another risk.

That’s part of the reason why officials aren’t penciling in any rate cuts until 2024.

“History cautions strongly against prematurely loosening policy,” Powell said. “We will stay the course until the job is done.”

Market participants aren’t so convinced. Investors aren’t thinking the Fed will keep rates high for long.

Federal funds rate futures currently show the Fed lifting rates to 4.75-5 percent and cutting them starting in September 2023, according to CME Group’s FedWatch. Experts say investors think the Fed will have to cut because the U.S. economy could enter a recession at some point next year, damaging the labor market and weighing on inflation more than the Fed is currently expecting.

“It’s not hard to imagine scenarios where they end up raising rates a fair amount next year,” says Bill English, finance professor at the Yale School of Management who spent 20 years at the Fed. “It’s also possible they end up cutting rates more if the economy really slows and inflation comes down a lot. It’s hard to be confident about your outlook. The best you can do is balance the risks.”

Why the Fed’s peak rate matters for consumers

Savers looking to maximize their earnings will want to pay close attention to the Fed’s terminal rate. It might indicate when yields will hit their ceiling, though banks’ offerings still depend on money-related supply and demand factors in addition to moves from the Fed.

Banks more than doubled their payouts last year, while individuals have seen even bigger earnings with high-yield savings accounts. McBride sees the highest-yielding accounts hitting a 5.25 percent yield by the end of 2023, which would be the highest since 2008.

Figuring out when the Fed will stop hiking rates is also important because of the debate that often follows: When to start cutting. Just don’t expect it to happen so soon.

The Fed would want to be “confident” that inflation is moving down to its 2 percent goal in a “sustained way” before making it cheaper to borrow money, Powell added at the Fed’s December post-meeting press conference.

“We think that we’ll have to maintain a restrictive stance of policy for some time,” Powell said.

Borrowers will certainly be holding their breath for that moment, especially would-be homebuyers who have been priced out of an already pricey housing market long before officials first started hiking rates at a breakneck pace. The 30-year fixed-rate mortgage more than doubled in 2022, hitting a 20-year high of 7.12 percent on Oct. 28.

But mortgage rates certainly don’t have to wait for the Fed’s word to start falling. Influencing the key home loan even more than the Fed is the 10-year Treasury yield. That key rate and then the 30-year fixed-rate mortgage could fall like dominoes if investors turn to thinking inflation has peaked — and instead, start to fret about a recession. Mortgage rates have since retreated to 6.3 percent as of Feb. 1.

A Bankrate survey of economists showed a 64 percent chance of a recession at some point in 2023.

The Fed isn’t shy about the consequences of higher rates. They’ve stopped short of saying they expect a recession but acknowledge pain may lie ahead. Policymakers saw unemployment rising to 4.6 percent by 2023 in their last projections from December, a 1.2 percentage point gain from its current level of 3.7 percent. That’s never happened without the U.S. economy being in a downturn.

“No one really knows where it’s going to end. The path is very narrow, and the Fed has to pull a rabbit out of their hat [to avoid a recession],” says Ryan Sweet, chief economist at Oxford Economics. “They’re going to break inflation no matter what. The risk is that they do too much.”