Biggest rate hike since 1994 | The Fed is not hiding its pessimism

(Washington) The US Federal Reserve (Fed) raised interest rates by three-quarters of a percentage point on Wednesday, the largest hike since 1994, as the central bank ramps up efforts to combat the fastest-growing inflation in four decades.

Updated yesterday at 6:20pm.

Jeanna Schmalek
The New York Times

what you need to know

  • North American stock indices rose immediately after the Fed’s announcement.
  • Economists from RBC and CIBC estimate that the Bank of Canada is likely to mimic the Fed by raising interest rates by 75 basis points next month.
  • Desjardins believes the Fed is “resolutely ready to hit hard to get inflation under control.” Further strong interest rate hikes are to be expected.
  • “To be clear, we’re not trying to create a recession,” Fed Chair Jerome Powell said reassuringly.

The press

The sharp rise in interest rates that markets were anticipating underscored the Fed officials’ determination to contain rising prices, even at the expense of the economy.

In a sign of the impact Fed policy is likely to have on the economy, officials have predicted the unemployment rate to hit 3.7% this year and 4.1% in 2024 and growth to slow significantly as policymakers would greatly increase the cost of borrowing and stifle economic demand.

The Fed’s interest rate is now in a range of 1.5% to 1.75% and policymakers have indicated that more rate hikes are imminent. In a new set of economic forecasts, the Fed expects interest rates to hit 3.4% by the end of 2022. That would be the highest level since 2008, and officials have estimated that its policy rate will hit 3.8% by the end of 2023. Those numbers are well above previous estimates, which called for a peak rate of 2.8% next year.

Fed officials have also recently hinted that they plan to cut rates in 2024, which could be a sign they believe the economy will weaken enough that they need to recalibrate their policy approach. The key takeaway from the Fed’s economic forecast, which it released for the first time since March, is that officials have become more pessimistic about their chances of a gentle slowdown in the economy.

To underscore this, policymakers dropped a phrase from their post-meeting statement that projected inflation could be subdued as the labor market remained strong – a sign they believe they need to rein in job growth to contain inflation check.

“Inflation remains high, reflecting pandemic-related supply and demand imbalances, rising energy prices and broader price pressures,” the Fed reiterated in its post-meeting statement.

One official, Kansas City regional Fed Chair Esther George, voted against the rate hike. Although Mme George had always worried about high inflation and had always been in favor of a rise in interest rates, in which case she would have preferred a half-point hike.

change of direction

By the end of last week, markets and economists broadly expected a half-point rise. The Fed had raised interest rates by a quarter point in March and a half point in May and indicated it intended to raise rates by those levels in June and July.

But central bankers have received a slew of bad news on inflation in recent days. The consumer price index rose 8.6% year-on-year in May, the fastest pace since late 1981.

Although the Fed’s preferred gauge of inflation — the measure of personal consumption spending — is slightly lower, it’s still too high to be comfortable. And consumers are starting to expect faster inflation in the coming months or even years, based on survey data, which is a worrying trend.

Economists believe expectations can be “self-fulfilling,” leading people to demand wage increases and accept price increases in a way that perpetuates high inflation.

It is becoming increasingly unlikely that the Fed will be able to bring inflation down quickly and smoothly to the 2% average and long-term target annual inflation rate.

The central bank has been working to put the economy on a more sustainable path without plunging it into a crushing recession that would cost jobs and dampen growth. Policymakers have hoped to raise the cost of borrowing to dampen demand just enough to balance supply and demand without causing major pain. However, as prices continue to rise, it is becoming increasingly difficult to achieve this “soft landing”.

Central bank rate hikes are already having an impact on the broader economy, pushing up mortgage rates and helping the housing market to cool. Demand for other consumer staples is showing signs of slowing as borrowing becomes more expensive and companies may scale back expansion plans.

The goal is to dampen demand enough for supply — which remains constrained by factory closures, shipping problems and labor shortages around the world — to catch up.

But it’s difficult to contain demand without hurting growth, not least because consumption makes up the bulk of the US economy. If the Fed has to cut spending drastically to curb rising prices, it could result in job losses and business closures.

Markets are increasingly concerned that central bank policies are causing a recession. Stock prices have fallen and bond market signals are flashing red as Wall Street traders and economists increasingly believe the economy may slide into recession as soon as next year.

This article was originally published in The New York Times.

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