The Federal Reserve raised interest rates by three-quarters of a percentage point on Wednesday, its biggest step since 1994, as the central bank ramps up efforts to tackle the fastest-growing inflation rate in four decades.
The big rate hike, which the markets had been expecting, has underlined that Fed officials are serious about crushing price hikes, even at the expense of the economy.
As a sign of how the Fed expects its policies to affect the economy, officials predicted that the unemployment rate would rise to 3.7 percent this year and 4.1 percent by 2024, and that growth would slow significantly as policymakers tighten the rules. drive up and stifle borrowing costs. on economic demand.
The Fed’s key rate has now been set in a range of 1.50 to 1.75 and policymakers suggested further rate hikes would follow. The Fed, in a new set of economic forecasts, was projecting interest rates to reach 3.4 percent by the end of 2022. That would be the highest level since 2008 and officials saw their key rate peak at 3.8 percent at the end of 2023. Those numbers are significantly higher than previous estimates, which showed rates next year at 2.8 percent.
Fed officials also recently indicated that they expect to cut interest rates in 2024, which could be a sign that they believe the economy will weaken so much that they will need to refocus their policy approach. The main conclusion of the Fed’s economic forecast, which it released for the first time since March, was that officials have become more pessimistic about their chances of a mild decline in the economy.
Policymakers underlined that, cutting a sentence from their statement after the meeting that predicted inflation would decline while the labor market remained strong — hinting that they think they need to curb job growth to get inflation under control.
“Inflation remains high, reflecting supply-demand imbalances related to the pandemic, higher energy prices and broader price pressures,” the Fed reiterated in its statement after the meeting.
An official, the president of the Federal Reserve Bank of Kansas City, Esther George, voted against the rate hike. While Ms. George has been concerned about high inflation in the past and prefers higher interest rates, in this case she would have preferred a half-point move.
Until late last week, markets and economists generally expected a half-point move. The Fed had raised rates by a quarter of a point in March and half a point in May, and said it would continue rising at that rate in June and July.
But central bankers have received a wave of bad news about inflation in recent days. The consumer price index rose 8.6 percent in May from a year earlier, the fastest rate of increase since late 1981, as monthly inflation remained solid even after excluding food and fuel prices.
While the Fed’s preferred inflation gauge – the measure of personal consumption expenditure – is slightly lower, it also remains too warm for comfort. And consumers are beginning to expect faster inflation in the coming months and even years, based on survey data, which is a worrying development. Economists believe that expectations can live up to themselves, leading people to demand wage increases and accept price increases in ways that maintain high inflation.
It is increasingly unlikely that the Fed will be able to cool inflation quickly and cautiously to the 2% annualized rate it is targeting on average and over time.
The central bank has tried to put the economy on a more sustainable path without pushing it into a crushing recession that is costing jobs and holding back growth. Policymakers have hoped to increase borrowing costs to reduce demand just enough to balance supply and demand without causing major pain. But as price increases prove to be intractable, achieving that so-called soft landing becomes more challenging.
The central bank’s rate hikes are already filtering through to the broader economy, driving mortgage rates higher and the housing market starting to cool. Demand for other consumer goods is beginning to decline as money becomes more expensive to borrow, and companies may shrink in their expansion plans.
The goal is to weigh demand enough to catch up with supply, which is limited by global factory closures, shipping problems and labor shortages.
But curbing demand without slowing growth is difficult, especially as consumption makes up the bulk of the US economy. If the Fed has to cut spending drastically to contain price increases, it could lead to job losses and business closures.
Markets increasingly fear that central bank policies will trigger a recession. Stock prices have fallen sharply and bond market signals are flashing red as Wall Street traders and economists increasingly expect the economy to plunge into a downturn next year.
