The Federal Reserve on Wednesday adopted its second straight rate hike of 0.75 percentage points as it seeks to reduce runaway inflation without creating a recession.
In raising the benchmark overnight lending rate to a range of 2.25%-2.5%, the moves in June and July represent the tightest consecutive moves since the Fed began using the overnight funds rate as its main monetary policy tool at the beginning of the 90s.
Although the fed funds rate most directly affects what banks charge each other for short-term loans, it feeds into a host of consumer products such as adjustable rate mortgages, auto loans and credit cards. The increase took the funds rate to its highest level since December 2018.
Markets had largely expected the move after Fed officials telegraphed the hike in a series of statements after the June meeting and held on to gains following the announcement. Central bankers have stressed the importance of reducing inflation, even if it means slowing the economy.
In its statement after the meeting, the Federal Open Market Committee, which sets interest rates, warned that “recent indicators of spending and output have softened.”
“However, job growth has been steady in recent months and the unemployment rate remains low,” the commission added, using language similar to the June statement. Officials again described inflation as “elevated” and attributed the situation to supply chain issues and higher food and energy prices, along with “broader price pressures”.
The rate hike was approved unanimously. In June, Kansas City Federal Reserve President Esther George dissented, arguing for a slower rate hike of half a percentage point.
The increases come in a year that began with interest rates hovering around zero, but in which a commonly cited measure of inflation is 9.1% a year. The Federal Reserve is targeting inflation of around 2%, although it is adjusting that target in 2020 to run a bit hotter in the interest of full and inclusive employment.
In June, the unemployment rate remained at 3.6%, close to full employment. But inflation, even by the Fed’s benchmark for core personal consumer spending, which was 4.7% in May, is well off target.
Efforts to reduce inflation are not without risks. The U.S. economy is teetering on the edge of recession as inflation slows consumer purchases and erodes business activity.
First-quarter GDP fell 1.6 percent year-on-year, and markets were bracing for a second-quarter report due on Thursday that could show consecutive declines, a widely used recession barometer. The Dow Jones forecast for Thursday is for a rise of 0.3%.
Along with raising interest rates, the Fed is reducing the amount of assets it holds on its balance sheet by nearly $9 trillion. In early June, the Fed began allowing some of the proceeds from maturing bonds to be disbursed.
The balance sheet has shrunk by just $16 billion since the downturn began, though the Fed set a cap of up to $47.5 billion that could potentially be lifted. The cap will rise over the summer, eventually reaching $95 billion per month by September. The process is known in the markets as “quantitative tightening” and is another mechanism the Fed uses to influence financial conditions.
Along with the accelerated runoff, markets expect the Fed to raise rates by at least another half a percentage point in September. Traders on Wednesday afternoon pegged about a 53 percent chance the central bank would go even further, with a third straight hike of 0.75 percentage points, or 75 basis points, in September, according to CME Group data.
The FOMC will not meet in August, but officials will gather in Jackson Hole, Wyoming, for the Fed’s annual meeting.
Markets expect the Fed to start cutting interest rates by next summer, although the committee’s projections released in June showed no cuts until at least 2024.
Multiple officials said they expected an aggressive hike until September, after which they would assess what impact the moves had on inflation. Despite the increases — a total of 1.5 percentage points between March and June — June’s consumer price index was the highest since November 1981, and the rent index was at its highest level since April 1986. and dental care costs hit a record in a data series dating back to 1995.
The central bank has faced critics both for being too slow to tighten when inflation first started to accelerate in 2021 and for possibly going too far and causing a more serious economic decline
Sen. Elizabeth Warren (D-Mass.) told CNBC on Wednesday that she worries the Fed’s hikes will pose an economic hazard to people at the bottom end of the economic spectrum by raising unemployment.
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