WASHINGTON (AP) — The Federal Reserve raised its benchmark interest rate by a hefty three-quarters of a point on Wednesday for the second straight time in its most aggressive drive in three decades to tame high inflation.
The Fed’s move would raise the key interest rate that affects many consumer and business loans to a range of 2.25% to 2.5%, its highest level since 2018.
The central bank’s decision follows a jump in inflation to 9.1%, the fastest annual rate in 41 years, and reflects its strained efforts to slow price rises across the economy. By raising interest rates on loans, the Federal Reserve makes it more expensive to get a mortgage or a car or business loan. Consumers and businesses are then likely to borrow and spend less, cooling the economy and slowing inflation.
The Federal Reserve has been tightening lending even as the economy has begun to weaken, raising the risk that interest rate hikes could trigger a recession later this year or next.
“I don’t think the U.S. is in a recession right now,” Chairman Jerome Powell said Wednesday at a news conference where he suggested the Fed’s rate hikes have already had some success in slowing the economy and possibly easing inflationary pressures.
That announcement, suggesting the Fed may not need to raise interest rates as aggressively in the coming months, helped spark a strong rally on Wall Street. The Dow Jones Industrial Average closed up 436 points.
Still, surging inflation and fears of a recession have undermined consumer confidence and fueled public anxiety about the economy, which is sending disappointingly mixed signals. And with November’s midterm elections approaching, American discontent has eroded President Joe Biden’s public approval rating and increased the likelihood that Democrats will lose control of the House and Senate.
The Fed’s moves to sharply tighten lending torpedoed the housing market, which is particularly sensitive to changes in interest rates. The average rate on a 30-year fixed mortgage has doubled in the past year to 5.5%, and home sales have collapsed.
Consumers are showing signs of cutting back on spending in the face of high prices. And business surveys show that sales are slowing. The central bank is betting it can slow growth enough to tame inflation but not enough to trigger a recession, a risk many analysts fear could end badly.
At his news conference, Powell suggested that with the economy slowing, demand for workers easing slightly and wage growth possibly peaking, the economy is developing in a way that should help reduce inflation.
“Are we seeing the slowdown in economic activity that we think we need?” he asked. “There is some evidence that we are.”
The Fed chairman also pointed to measures that suggest investors expect inflation to fall back to the central bank’s 2 percent target over time as a sign of confidence in its policies.
Powell also stood by the forecast Fed officials made last month that their benchmark interest rate would reach a range of 3.25% to 3.5% by the end of the year and roughly half a percentage point higher in 2023. That forecast, if maintains, would mean a delay in Fed hikes. The central bank would meet its goal at the end of the year if it raises its key interest rate by half a point when it meets in September and by a quarter point at each of its meetings in November and December.
With the Federal Reserve having already imposed two significant rate hikes in a row, “I really think they’re going to tiptoe out of here,” said Thomas Garretson, senior portfolio strategist at RBC Wealth Management.
Garrettson expects the Fed to raise its key interest rate by a quarter point in September and November before pausing its hikes. He also said he worries that Powell may be underestimating the damage higher rates are doing to the labor market. Pointing to a steady increase in the number of Americans seeking unemployment benefits, Garretson said “cracks” may be appearing in what has been a stable labor market.
On Thursday, when the government estimates gross domestic product for the April-June period, some economists said it could show the economy shrank for a second straight quarter. That would answer a long-held guess about when the recession began.
But this does not necessarily mean a recession has begun, according to economists. In those same six months, when the overall economy may have contracted, employers added 2.7 million jobs — more than in most entire years before the pandemic. Wages are also growing at a healthy pace, with many employers still struggling to attract and retain enough workers.
Still, the slowdown presents Fed policymakers with a high-stakes dilemma: How high should they raise interest rates if the economy slows? Weaker growth, if it causes layoffs and raises unemployment, often reduces inflation by itself.
This dilemma could become even more acute for the Fed next year, when the economy may be in worse shape and inflation is likely to exceed the central bank’s 2% target.
“How much recession risk are you willing to take to get (inflation) back to 2 percent quickly, compared to a few years?” asked Nathan Sheets, a former Fed economist who is global chief economist at Citi. “These are the issues they will have to contend with.”
Economists at Bank of America predict a “mild” recession later this year. Goldman Sachs analysts estimate a 50-50 chance of a recession within two years.
Among analysts predicting a recession, most predict it will be relatively mild. The unemployment rate, they note, is near a 50-year low, and households are generally in sound financial shape, with more money and less debt than they have since the housing bubble burst in 2008.
___
AP Economics writer Paul Wiseman contributed to this report.
Add Comment