Federal Reserve raises key interest rate another 0.75 percentage point and matches biggest increase since 1994 in push to tame soaring inflation
- Federal Reserve on Wednesday increased its key overnight borrowing rate by 0.75 points
- The move brings the target rate to 2.25-2.50 percent, matching the recent highs seen in 2019
- Central bank has been pursuing rapid rate hikes to battle soaring inflation, which hit 9.1% in June
The Federal Reserve on Wednesday increased its key interest rate by three-quarters of a percentage point for the second month in a row, matching the biggest increase since 1994.
The move brings the target rate to between 2.25 percent and 2.50 percent, which is where it stood in the summer of 2019, its most recent high before the COVID-19 pandemic struck.
It represents one of the fastest-ever gear changes in U.S. monetary policy: Just over four months ago the policy rate was near zero and the Fed was buying billions of dollars of bonds each month to pump up the economy.
Interest rates are the Fed’s key tool in trying to lower inflation from a four-decade high, and the central bank is pursuing an aggressive rates path after consumer prices jumped 9.1% in June from a year ago.
Still, Wednesday’s move was widely expected, and markets reacted calmly to the news, with the major stock indexes maintaining their gains following the Fed’s announcement.
The Federal Reserve on Wednesday increased its key interest rate by three-quarters of a percentage point. Fed Chair Jerome Powell is seen above
The Fed hopes to pull off a delicate feat of central banking: Slow the economy just enough to curb inflation without causing a recession. Many economists doubt the Fed can manage that feat, a so-called soft landing.
Surging inflation is most often a side effect of a red-hot economy, not the current tepid pace of growth.
Today’s economic moment conjures dark memories of the 1970s, when scorching inflation co-existed, in a kind of toxic brew, with slow growth. It hatched an ugly new term: stagflation.
The United States isn’t there yet. Though growth appears to be faltering, the job market still looks quite strong. And consumers, whose spending accounts for nearly 70 percent of economic output, are still spending, though at a slower pace.
By the time of the Fed’s next meeting on September 20-21, policymakers will have two months of additional data on inflation, consumer spending, business output, jobs, and other aspects of the economy.
If inflation does slow before that meeting, it could clear the way for the Fed to slow its pace of rate hikes.
Rising interest rates impact borrowing costs for consumers, making loans more expensive
Investors, as of now, are roughly split over whether that will happen, with data likely to continue pulling in both directions.
The U.S. economy ‘is likely to have contracted in the first half of the year, but job growth remains robust,’ Greg Daco, chief economist at EY-Parthenon, wrote this week.
‘Inflation is leading to record-low consumer sentiment, but consumers are still spending,’ added Daco. The U.S. right now is ‘a world of paradox.’
The central bank´s decision follows a jump in inflation to 9.1 percent, the fastest annual rate in 41 years, and reflects its strenuous efforts to slow price gains across the economy.
By raising borrowing rates, the Fed makes it costlier to take out a mortgage or an auto or business loan. Consumers and businesses then presumably borrow and spend less, cooling the economy and slowing inflation.
The Fed is tightening credit even while the economy has begun to slow, thereby heightening the risk that its rate hikes will cause a recession later this year or next. The surge in inflation and fear of a recession have eroded consumer confidence and stirred public anxiety about the economy, which is sending frustratingly mixed signals.
With the November midterm elections nearing, Americans´ discontent has diminished President Joe Biden´s public approval ratings and increased the likelihood that the Democrats will lose control of the House and Senate.
The Fed´s moves to sharply tighten credit have torpedoed the housing market, which is especially sensitive to interest rate changes. The average rate on a 30-year fixed mortgage has roughly doubled in the past year, to 5.5%, and home sales have tumbled.
At the same time, consumers are showing signs of cutting spending in the face of high prices. And business surveys suggest that sales are slowing.
The central bank is betting that it can slow growth just enough to tame inflation yet not so much as to trigger a recession – a risk that many analysts fear may end badly.
The average rate on a 30-year fixed mortgage has roughly doubled in the past year, to 5.5%, and is expected to rise further
In a statement the Fed issued after its latest policy meeting ended, it acknowledged that while ‘indicators of spending and production have softened,’ ‘job gains have been robust in recent months, and the unemployment rate has remained low.’ The Fed typically assigns high importance to the pace of hiring and pay growth because when more people earn paychecks, the resulting spending can fuel inflation.
On Thursday, when the government estimates the gross domestic product for the April-June period, some economists think it may show that the economy shrank for a second straight quarter. That would meet one longstanding assumption for when a recession has begun.
But economists say that wouldn´t necessarily mean a recession had started. During those same six months when the overall economy might have contracted, employers added 2.7 million jobs – more than in most entire years before the pandemic. Wages are also rising at a healthy pace, with many employers still struggling to attract and retain enough workers.
Still, slowing growth puts the Fed´s policymakers in a high-risk quandary: How high should they raise borrowing rates if the economy is decelerating? Weaker growth, if it causes layoffs and raises unemployment, often reduces inflation on its own.
That dilemma could become an even more consequential one for the Fed next year, when the economy may be in worse shape and inflation will likely still exceed the central bank´s 2% target.
‘How much recession risk are you willing to bear to get (inflation) back to 2%, quickly, versus over the course of several years?’ asked Nathan Sheets, a former Fed economist who is global chief economist at Citi. ‘Those are the kinds of issues they´re going to have to wrestle with.’
Economists at Bank of America foresee a ‘mild’ recession later this year. Goldman Sachs analysts estimate a 50-50 likelihood of a recession within two years.
Among analysts who foresee a recession, most predict that it will prove relatively mild. The unemployment rate, they note, is near a 50-year low, and households are overall in solid financial shape, with more cash and smaller debts than after the housing bubble burst in 2008.
Fed officials have suggested that at its new level, their key short-term rate will neither stimulate growth nor restrict it – what they call a ‘neutral’ level. Chair Jerome Powell has said the Fed wants its key rate to reach neutral relatively quickly.
Should the economy continue to show signs of slowing, the Fed may moderate the size of its rate hikes as soon as its next meeting in September, perhaps to a half-point. Such an increase, followed by possibly quarter-point hikes in November and December, would still raise the Fed´s short-term rate to 3.25% to 3.5% by year´s end — the highest point since 2008.