Fed Lifts Rates a Quarter Point in Opening Bid to Curb Inflation
Federal Reserve increased interest rates by 25% and indicated six additional increases this year. This campaign aims to combat the highest inflation rate in 40 years, even though there are risks to economic growth.
The 8-1 vote by policy makers headed by Jerome Powell to raise their key rate from 0.25% to 0.5% was the first since 2018. This is after two years in which borrowing costs were near zero, to protect the economy against the pandemic. James Bullard, President of the St. Louis Fed, voted against a half point hike. This is the first vote against an increase since September 2020.
The hike is likely the first of several to come this year, as the Fed said it “anticipates that ongoing increases in the target range will be appropriate,” and Powell has pledged to be “nimble.”
In the Fed’s so-called dot plot, officials’ median projection was for the benchmark rate to end 2022 at about 1.9% — in line with traders’ bets but higher than previously anticipated — and then rise to about 2.8% in 2023. They estimated a 2.8% rate in 2024, the final year of the forecasts, which are subject to even more uncertainty than usual given Russia’s invasion of Ukraine and new Covid-19 lockdowns in China are buffeting the global economy.
“The invasion of Ukraine by Russia is causing tremendous human and economic hardship,” the Federal Open Market Committee said in a statement Wednesday following a two-day meeting in Washington, the first held in person—rather than via videoconference—since the pandemic began. “The implications for the U.S. economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.”
The two-year Treasury yields shot up and the curve flattened quickly following the announcement. The S&P 500 index pared its gains and the dollar index saw little reaction.
The Fed said it would begin allowing its $8.9 trillion balance sheet to shrink at a “coming meeting” without elaborating. This month’s purchases of Treasuries, mortgage-backed securities and Treasuries were made to support the economy in the Covid-19 crisis. Shrinking the balance sheet speeds up the end of this aid.
Powell currently serves as pro-tempore chair while waiting for Senate confirmation. A virtual press conference was planned at 2:30 pm Washington time.
The Fed faces the arduous task of securing a soft landing for the world’s largest economy for the first time since the early 1990s. To tighten too quickly, it could allow inflation to spiral out of control. This would require even more drastic action. Too fast and the central banks could destabilize markets and plunge the economy into recession.
Complicating the job: Russia’s invasion of Ukraine has sent the cost of fuel, food and metals racing even higher, raising fears of 1970s-style stagflation by posing threats to prices, growth and financial-market stability.
Officials at the Fed have released new economic projections. They see inflation rising significantly, to 4.3% in 2019, but falling to 2.3% by 2024. While the forecasts for economic growth were reduced to 2.8%, unemployment projections were unchanged.
Three months ago, policymakers expected only three quarter-point rate hikes this year. The pivot towards tighter monetary policies is more dramatic than they saw.
This has led to an increase in inflation that is stronger and more persistent than predicted. The consumer price index soared 7.9% in February, the most since 1982; the Fed’s 2% inflation target is based on a separate gauge, the personal consumption expenditures price index, which rose 6.1% in the 12 months through January.
Officials believed that the inflation shock will fade after the economy returns to normal. However, the Fed held back from increasing rates in the past because they were cautious due to new Covid-19 variants as well data showing an uncertain recovery.
However, prices rose due to a mix of government stimuli, tightening labor markets and surging commodity costs. Frayed supply chains also contributed to the price increases. Powell also operated under the Fed’s policy framework adopted mid-2020 to permit some inflation above target in hopes of expanding employment.
Critics argue that the Fed is too slow to adjust its course. It’s now behind the curve taking on price gains. If companies continue to pass high costs onto consumers, they could make the situation worse. This would lead them demand higher wages.
Powell is also awaiting Senate confirmation to increase rates. However, Powell’s worsening inflation outlook has given him political cover. American businesses and households have responded with concern to the rising cost of gasoline, which is now at $4 per gallon. However, it may fall after the recent drop in crude oil prices.
President Joe Biden has called taming inflation his top economic priority, while fellow Democrats worry failure to restrain prices could cost them their thin congressional majorities in November’s midterm elections.
Powell also rejected calls to increase the half-point rate by Powell, which would be the largest since 2000. Some on Wall Street reckon it could deliver such a salvo in coming months if inflation doesn’t retreat.
Positively, American households are strong with 3.8% unemployment and a rise in savings throughout the pandemic.
Bloomberg Economics forecasts that rates could rise to 3.25% next year. That would be the largest increase in rate since 2008. Now, policymakers see the long-term federal funds rate at 2.4% as opposed to 2.5% in December’s forecast.
Not only is the Fed becoming more hawkish, but so are other central banks. Last week, the European Central Bank surprised everyone by announcing that it will be less aggressive in cutting back on bond-buying. The Bank of England is also set to lift rates on Thursday for a third straight meeting, while Brazil’s central bank is predicted to hike by another 100 basis points on Wednesday.
— With assistance from Jordan Yadoo and Liz Capo McCormick.