WASHINGTON –
The US Federal Reserve on Wednesday stepped up its efforts to curb high inflation by raising its key interest rate by three-quarters of a point – its biggest increase in nearly three decades – and signaling higher interest rates, which will increase risk from another recession.
The unusually large rise in interest rates came after data released on Friday showed that US inflation rose to a four-decade high of 8.6% last month, a surprise jump that has caused financial markets to worry about how the Fed will react. The Fed’s reference short-term interest rate, which affects many consumer and business loans, will now be set at 1.5% to 1.75% – and Fed politicians predict a doubling of that range by the end of the year.
“We felt that strong action was needed at this meeting, and we did,” Fed Chairman Jerome Powell told a news conference, stressing the central bank’s commitment to do what it takes to reduce inflation to the Fed’s 2 percent target. Reaching that point, he said, could lead to a slightly higher unemployment rate as economic growth slows.
Powell said it was necessary to increase the increase by half a point, which the Fed had previously signaled, as inflation was hotter than expected – causing particular difficulty for low-income Americans. Another concern is that society is increasingly expecting higher inflation in the future, which could become a self-fulfilling prophecy by accelerating spending among consumers seeking to avoid rising prices for certain goods.
The central bank has revised its political statement to acknowledge that its efforts to curb inflation will not be painless, removing the previous language that said Fed officials expect “the labor market to remain strong.”
“It will be a much more unfavorable journey to reduce inflation than previously expected,” said Matthew Lucetti, chief US economist at Deutsche Bank.
Fed officials predict that unemployment will rise this year and next, reaching 4.1 percent in 2024, a level that some economists say will risk a recession.
Yet Powell largely adheres to his previous assurances that – with unemployment close to the lowest level in five decades, rising wages and, above all, sound consumer finances – the economy can withstand higher interest rates and avoid recession.
“We are not trying to cause a recession now,” he said. “Let’s make this clear. We are trying to achieve 2% inflation. “
Powell said another three-quarter increase was possible at the next Fed meeting in late July if inflationary pressures remain high, although he said such increases would not be common.
Some financial analysts have suggested that Powell struck the right balance to reassure markets that rose on Wednesday. “He hit hard that ‘we want to cut inflation’, but he also hit hard that ‘we want a soft landing,'” said Robert Tip, chief investment strategist at PGIM Fixed Income.
However, the Fed’s actions on Wednesday acknowledged that it is struggling to curb the pace and resilience of inflation, fueled by strong consumer spending, pandemic disruptions and rising energy prices that have been exacerbated by Russia’s invasion of Ukraine. .
Inflation rose to the top of voters’ concerns in the months leading up to the congressional by-elections, worsening public opinion about the economy, weakening President Joe Biden’s approval rating and increasing the likelihood of losing Democrats in November.
Biden has tried to show that he is aware of the pain that inflation is causing American households, but is struggling to find political action that could make a real difference. The president stressed his conviction that the power to curb inflation is primarily the responsibility of the Fed.
Still, the Fed’s interest rate hikes are dumb tools to try to reduce inflation while sustaining growth. Shortages of oil, petrol and food are contributing to higher prices. Powell said several times during the press conference that such factors are beyond the control of the Fed and could force him to raise interest rates even higher to ultimately reduce inflation.
Borrowing costs have already risen sharply in much of the US economy in response to the Fed’s actions, with the average 30-year fixed interest rate on mortgages exceeding 5%, its highest level since the 2008 financial crisis, compared to just 3 % in the beginning of the year.
In their updated forecasts on Wednesday, Fed politicians said that after this year’s increase in interest rates, they predict two more increases in interest rates by the end of 2023, at which point they expect inflation to finally fall below 3%, close to the target their level. But they expect inflation to still be 5.2% by the end of this year, much higher than in March.
Over the next two years, officials forecast a much weaker economy than was forecast in March. They forecast growth of 1.7% this year and next. This is below their forecasts in March, but better than some economists expect a recession next year.
Even if the Fed manages the delicate trick of curbing inflation without causing a fall, higher interest rates will still put pressure on stocks. The S&P 500 has already sunk by more than 20% this year, meeting the bear market definition.
On Wednesday, the S&P 500 rose 1.5%. The two-year government bond yield fell to 3.23% from 3.45% late Tuesday, with the biggest move coming after Powell said he did not expect a three-quarters-percentage point increase in interest rates to be normal.
Other central banks are also trying to curb inflation, even when their nations are at greater risk of recession than the United States.
The European Central Bank is expected to raise interest rates by a quarter in July, its first increase in 11 years. It could announce a bigger increase in September if record high inflation rates persist. On Wednesday, the ECB pledged to create market protection that could protect member states from financial turmoil of the kind that erupted during the debt crisis more than a decade ago.
The Bank of England raised interest rates four times from December to a 13-year high, despite forecasts that economic growth will remain unchanged in the second quarter. BOE will hold a meeting on interest rates on Thursday.
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