WASHINGTON (AP) – The Federal Reserve stepped up its fight against high inflation on Wednesday, raising its key interest rate by three quarters – the highest since 1994 – and signaling further interest rate hikes ahead as it tries to cool US economy without causing a 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 thought decisive action was needed at this meeting, and we did it,” Fed Chairman Jay Powell told a news conference, stressing the central bank’s commitment to doing what it takes to bring inflation back to the Fed’s target. 2%, even if this leads to a slightly higher unemployment rate.
Powell said it was imperative to reach more than the half-point increase the Fed had previously signaled, as inflation was hotter than expected – causing particular difficulty for low-income Americans – and that public expectations of rising inflation have become stronger.
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. He said the economy is strong enough to withstand higher rates without falling into recession, a prospect many economists are increasingly worried about.
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 action on Wednesday was a recognition that it is struggling to curb the pace and persistence of inflation fueled by a strong labor market linked to pandemic disruptions in supply and rising energy prices, exacerbated by Russia’s invasion of Ukraine. .
Some analysts said they welcomed the Fed’s more aggressive stance. “The more the Fed does now, the less they will have to do later,” said Thomas Garrettson, senior portfolio strategist at RCB Wealth Management.
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. The shortage of oil, gasoline and food is escalating prices. The Fed is not ideally suited to tackle many of the roots of inflation, which include Russia’s invasion of Ukraine, still congested global supply chains, labor shortages and growing demand for airline tickets to restaurant meals.
At his press conference, Powell made a defensive note when asked if the Fed was ready to accept the recession as a price to limit inflation and bring it closer to the Fed’s 2% target.
“We are not trying to cause a recession now,” he said. “Let’s make this clear. We are trying to achieve 2% 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.
Even if the recession can be avoided, economists say it is almost inevitable the Fed will have to inflict some pain – most likely in the form of higher unemployment – at the cost of overcoming chronically high inflation.
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 expect the unemployment rate to reach 3.7% by the end of the year and 3.9% by the end of 2023. These are only slight increases from the current 3.6% unemployment. But they mark the first time he has raised interest rates when the Fed acknowledged that his actions would weaken the economy.
The central bank also sharply lowered its forecasts for economic growth to 1.7% this year and next. This is below his forecasts in March, but better than some economists expect a recession next year.
Investments around the world, from bonds to bitcoins, have collapsed amid fears of inflation and the prospect that the Fed’s aggressive drive to control it will trigger a recession. 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 on Tuesday, with the biggest move coming after Powell said he did not expect a 0.75 percentage point rise in interest rates.
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.
Last week, the World Bank warned of the threat of stagflation – slow growth accompanied by high inflation – around the world.
Robert Tip, chief investment strategist at PGIM Fixed Income, suggested that Powell had found a balance sheet that calmed the financial markets. “He hit hard that we want to reduce inflation, but he also hit hard that we want a soft landing,” Tip said.
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