(Washington D.C.) — The Federal Reserve on Wednesday intensified its drive to tame high inflation by raising its key interest rate by three-quarters of a point — its largest hike in nearly three decades — and signaling more large rate increases to come that would raise the risk of another recession.
After its last policy meeting, the Fed raised its benchmark short term rate to 1.5% to 1.75%. This affects many business and consumer loans. With the additional rate hikes they foresee, the policymakers expect their key rate to reach a range of 3.25% to 3.5% by year’s end — the highest level since 2008 — meaning that most forms of borrowing will become sharply more expensive.
With inflation at 8.6% (a 4-decade-high), the central bank has intensified its efforts to slow growth and tighten credit. This is spreading to other areas of economy and shows no signs of slowing. Americans have begun to believe that high levels of inflation will last for longer periods than before. This sentiment could embed an inflationary psychology in the economy that would make it harder to bring inflation back to the Fed’s 2% target.
The Fed’s three-quarter-point rate increase exceeds the half-point hike that Chair Jerome Powell had previously suggested was likely to be announced this week. The Fed’s decision to impose a rate hike as large as it did Wednesday was an acknowledgment that it’s struggling to curb the pace and persistence of inflation, which has been worsened by Russia’s war against Ukraine and its effects on energy prices
Speaking at a news conference Wednesday, Powell suggested that another three-quarter-point hike is possible at the Fed’s next meeting in late July, if inflation pressures remain high. Asked why the Fed was announcing a more aggressive rate hike than he had earlier signaled it would, Powell replied that the latest data had shown inflation to be hotter than expected and that the public’s inflation expectations have accelerated.
“We thought strong action was warranted at this meeting,” he said, “and we delivered that.”
Inflation has shot to the top of voter concerns in the months before Congress’ midterm elections, souring the public’s view of the economy, weakening President Joe Biden’s approval ratings and raising the likelihood of Democratic losses in November. Biden tried to demonstrate that he understands the suffering that American families are experiencing from inflation, but has not been able to identify policy options that could make an impact. He has reiterated his belief in the Fed’s ability to control inflation.
Yet the Fed’s rate hikes are blunt tools for trying to lower inflation while also sustaining growth. Inflation is rising because of escalating food and fuel prices. The Fed isn’t ideally suited to address many of the roots of inflation, which involve Russia’s invasion of Ukraine, still-clogged global supply chains, labor shortages and surging demand for services from airline tickets to restaurant meals.
Powell responded defensively to a question about whether Powell would now accept that a recession is part of the cost to curb inflation and get it to 2.5% target.
“We’re not trying to induce a recession now,” he said. “Let’s be clear about that. We’re trying to achieve 2% inflation.”
Learn More: The U.S. inflation rate unexpectedly accelerates to an unprecedented 40-year high of 8.6%
Borrowing costs have already risen sharply across much of the U.S. economy in response to the Fed’s moves, with the average 30-year fixed mortgage rate topping 6%, its highest level since before the 2008 financial crisis, up from just 3% at the start of the year. As a reference for corporate borrowing, the yield on the 2-year Treasury Note has increased to 3.3%. This is its highest point since 2007.
Even if a recession can be avoided, economists say it’s almost inevitable that the Fed will have to inflict some pain — most likely in the form of higher unemployment — as the price of defeating chronically high inflation.
In their updated forecasts Wednesday, the Fed’s policymakers indicated that after this year’s rate increases, they foresee two more rate hikes by the end of 2023, at which point they expect inflation to finally fall below 3%, close to their target level. But they expect inflation to still be 5.2% at the end of this year, much higher than they’d estimated in March.
Officials expect the economy to be much less strong than it was in March. They expect the unemployment rate to reach 3.7% by year’s end and 3.9% by the end of 2023. These are slight rises from the 3.6% unemployment rate. They are however the Fed’s first acknowledgment that raising interest rates will hurt the economy since its inception.
Also, the central bank has sharply reduced its expectations for economic growth to 1.7% next year and this year. That’s below its outlook in March but better than some economists’ expectation for a recession next year.
A range of interest rates have reached their highest levels in many years due to expectations for higher Fed increases. The 2-year Treasury yield, which is a reference for corporate bonds has reached 3.3%. This marks its highest point since 2007. The 10 year Treasury yield which directly impacts mortgage rates has reached 3.4%. It was the highest point since 2011.
Investments around the world, from bonds to bitcoin, have tumbled on fears surrounding inflation and the prospect that the Fed’s aggressive drive to control it will cause a recession. Although the Fed may manage the tricky task of controlling inflation and not creating a slump, stocks will still be under pressure if rates rise. The S&P 500 has already sunk more than 20% this year, meeting the definition of a bear market.
Other central banks have also stepped up to curb inflation. This is despite the fact that their countries are more at risk than the U.S. for recession. In July, the European Central Bank will raise rates by 25%. This is its 11th consecutive increase. If inflation remains at record highs, the ECB could announce an even larger rate hike for September. On Wednesday, ECB announced that it would create a market backingstop to protect its member countries from the same financial crisis that erupted more than a century ago.
The Bank of England raised interest rates four times in December, to an unprecedented 13-year record. This despite the fact that there are no forecasts of economic growth for the second quarter. On Thursday, the BOE will host an interest rate meeting.
Last week, the World Bank warned of the threat of “stagflation” — slow growth accompanied by high inflation — around the world.
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