The Federal Reserve raised its benchmark interest rate by a quarter of a percentage point on Wednesday as policymakers took their decisive first step in trying to tame rapid inflation by raising financial costs.
Fed officials have kept interest rates close to zero since March 2020, when the pandemic began to shake the US economy, and this week’s decision was the first rate hike since 2018. Policy makers have predicted more. six moves of similar size over the course of 2022 as inflation hit a 40-year high, signaling they are poised to significantly withdraw support for the economy.
“The economy no longer needs – or wants – this very accommodating stance,” Fed chairman Jerome H. Powell said at his post-meeting press conference.
The central bank’s assault on rapid price increases will force it to strike a delicate balance as politicians try to slow the economy just enough to moderate demand and allow price pressures to moderate without going so far as to plunge. the United States in the recession.
Powell said that, in his view, “the likelihood of a recession within the next year is not particularly high” and that “all signs are that this is a strong economy and, indeed, able to thrive” with less political aid.
“The economy, we think, can handle rising interest rates,” he said.
Despite the forecast for higher rates, stocks rose 2.2% on Wednesday, a possible sign that investors took courage in Powell’s insistence that the economy was strong enough to resist the bank’s efforts to slow. inflation.
The Fed’s decision to raise rates was a turning point after two years of trying to help the economy recover from the damage inflicted by the pandemic. As the coronavirus continues to disrupt trade around the world, the US economy has recovered rapidly. The American job market has rebounded rapidly from heavy job losses due to the pandemic, and companies are now struggling to find workers.
An increase in consumer spending has helped push the inflation rate to levels not seen since the 1980s. Instead of echoing the anemic delay of the 2007-9 recession, which kept millions of jobless candidates and left inflation tepid despite years of very low rates, the rebound of the pandemic has been vigorous.
Judging by inflation, it may even have too much heat, which is why the Fed is trying to cool it at a more sustainable pace.
“We’ve had price stability for a long time, and maybe we’ve come to take it for granted, but now we see the pain,” Powell said. “We are strongly committed, as a committee, not to allow this increased inflation to take root and to use our tools to bring inflation back to more normal levels.”
Central bankers have drawn a more aggressive plan to control inflation than they did in December, when they last published the economic projections. Officials now plan to raise rates to 2.8% by the end of 2023, based on the median estimate, up from 1.6% in their previous projections. This is high enough that, according to estimates by the Fed itself, it could be equivalent to pressing the brakes on the economy, not just taking one foot off the accelerator.
“They knew their policy did not match the economic environment and this is a recovery,” said Priya Misra, head of global rate strategy at TD Securities.
Higher interest rates will come out of the markets to make mortgages, because business loans and loans are more expensive. This should slow consumption and investment, reduce demand in the economy and, Fed officials hope, eventually weigh down the price increase.
Given the path forward for interest rate hikes and how they seep through the economy, some economists have argued that the central bank’s forecast for strong growth and very low unemployment this year and next they might be optimistic.
“It’s a somewhat magical and immaculate disinflation,” said Michael Feroli, JP Morgan’s US chief economist. “Even if they don’t say it or show it in their forecasts, at some point it is necessary to slow down the economy.”
Five Fed officials now think rates could be over 3% by the end of 2023.
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judgment of the official.
Each square represents the vision of a Fed official.
Five Fed officials now think rates could be over 3% by the end of 2023.
Mr. Powell noted Wednesday that inflation was “well above” the Fed’s target and that the supply chain disruptions had been larger and more lasting than officials expected. Now price hikes are spreading to rent and other services, and high gas prices could keep costs high, he noted.
The Fed’s quarterly economic projections, released alongside the rate decision, showed officials expected inflation to be 4.3% by the end of 2022. Although it is less than the 6.1% increase in the 12 months to January, is more than double that of the Fed. 2 percent target.
The Fed is aiming for maximum employment as well as price stability and many signs suggest it is reaching that goal. Unemployment has dropped dramatically, job opportunities are plentiful, and there are too few workers to go around. A booming job market has helped push wage growth higher as employers compete for workers and try to keep employees by paying more.
But even that could risk fueling inflation. Higher pay gives workers more to spend and leaves companies trying to cover rising labor costs. From a price stability perspective, Powell said, recent wage growth has not been sustainable.
There is a “mismatch between supply and demand, particularly in the labor market, and this is driving wages to rise in ways that are inconsistent with 2% inflation over time,” he said.
As signs of seething price pressures abound, some Fed officials have become nervous. James Bullard, the chairman of the Federal Reserve Bank of St. Louis, voted against the committee’s decision because he was in favor of a larger hike in interest rates by half a percentage point.
Bullard and some other Fed officials said a faster rate hike at the start would show that the central bank was ready to push back the rapid price hikes.
But Powell made it clear on Wednesday that while he is steadily raising rates instead of sharply adjusting them at first, the Fed’s policy committee knows it needs to act to restore price stability.
“We’re not going to let high inflation take root,” Powell said.
The Fed is changing policy at a fragile time. The Russian invasion of Ukraine raised obstacles to steady economic growth around the world, even as it raised oil and gas prices and threatened to perpetuate tangled supply chains and high inflation.
“The implications for the US economy are highly uncertain,” the Federal Open Market Committee said in its statement Wednesday. “But in the short term, the invasion and related events are likely to create further upward pressure on inflation and weigh on economic activity.”
The central bank does not want to feed uncertainty at a geopolitically difficult time, and Mr. Powell has gone to great lengths to clearly define his plans. While he did not commit to a quarter-point rate hike at each meeting, he noted that many officials expect the same number of rate changes as there are meetings left in 2022, including this week, for a total. of seven.
Markets are also watching closely to see when the Fed will begin cutting its balance sheet by nearly $ 9 trillion in bonds, a policy move that could push long-term interest rates higher. Mr. Powell clarified that a plan could come as soon as the Fed’s May meeting and that it will look a lot like the one the bank used when it reduced its balance sheet from 2017 to 2019, albeit earlier and faster.
As the Fed acts to control inflation, the impact is likely to be palpable. Mortgage rates have already risen as the central bank signaled its impending policy changes.
Higher borrowing costs are likely to impact hiring, slow wage growth, and prevent asset prices, including stock and home prices, from rising as much as they attract buyers and investors.
A recession is a possibility whenever the Fed raises interest rates, but allowing inflation to rise unchecked could also be a risk. Wednesday’s retail sales data has already offered a first clue that higher prices could make it harder for some consumers to afford things. Households are sitting on the large savings accumulated during the pandemic, which could help them sustain their spending in the coming months, but the rapid price increases could eventually consume those stocks.
“High inflation impacts everyone, but really, particularly, people who use most of their income to buy basic necessities like food, shelter and transportation,” Powell said.
Economists have said a repeat of the painful early 1980s, when the Fed caused a deep recession while battling inflation, is unlikely. But many have warned that a sweet and easy end to the current inflationary outbreak is not assured.
“It’s too early to say it’s a pipe dream; It’s been a crazy year, “Harvard University economist Jason Furman said earlier this week about the possibility of a soft landing.” It seems, with each passing month, more and more unlikely. “