On Wednesday, the Federal Reserve launched its largest broadside to date against inflation, raising reference rates by three quarters of a percentage point in a move that corresponds to the most aggressive increase since 1994.
At the end of weeks of speculation, the Federal Open Market Committee’s interest rate-setting benchmark raised its benchmark fund rate to 1.5% -1.75%, the highest since just before the Covid pandemic began in March 2020.
The shares were volatile after the decision, but increased when Fed Chairman Jerome Powell spoke at his press conference after the meeting.
“It is clear that the current increase of 75 basis points is unusually large, and I do not expect movements of this magnitude to be common,” Powell said. However, he added that he expects the July meeting to see an increase of 50 or 75 basis points. He said decisions would be made “face to face” and that the Fed would “continue to communicate our intentions as clearly as we can.”
“We want to see progress. Inflation cannot go down until it flattens out,” Powell said. “If we do not see progress … it can make us react. Soon enough we will see some progress.”
FOMC members indicated a much stronger path for interest rate hikes going forward to stop inflation moving at its fastest pace back to December 1981, according to an oft-cited target.
The Fed’s reference rate will end the year at 3.4%, according to the midpoint of the target range for individual members’ expectations. This is compared with an upward adjustment of 1.5 percentage points from the estimate for March. The committee then sees that the rate rises to 3.8% in 2023, a full percentage point higher than what was expected in March.
Cuts in growth prospects for 2022
Officials also significantly reduced the outlook for economic growth in 2022, and now expect only a 1.7% increase in GDP, down from 2.8% from March.
The inflation estimate measured by personal consumption expenditure also rose to 5.2 per cent this year from 4.3 per cent, although core inflation, which excludes rapidly rising food and energy costs, is indicated at 4.3 per cent, up only 0.2 percentage points from the previous estimate. . Core PCE inflation ran at 4.9% in April, so projections on Wednesday expect a easing of price pressure in the coming months.
The committee’s statement painted a largely optimistic picture of the economy, even with higher inflation.
“General economic activity appears to have picked up after a decline in the first quarter,” the statement said. “Job gains have been robust in recent months, and unemployment has remained low. Inflation remains high, reflecting supply and demand imbalances related to the pandemic, higher energy prices and broader price pressures.”
The estimates expressed through the committee’s summary of economic projections actually show that inflation is moving sharply down in 2023, down to 2.6% headline and 2.7% core, expectations changed little from March.
In the longer term, the Committee’s policy outlook is broadly in line with market forecasts, which see a number of increases ahead that will bring the fund’s yield to around 3.8%, the highest level since the end of 2007.
The statement was approved by all FOMC members except Kansas City Fed President Esther George, who preferred a small increase of half a point.
Banks use the exchange rate as a measure of what they charge each other for short-term loans. However, it flows directly through to a number of consumer debt products, such as adjustable rate mortgages, credit cards and car loans.
The fund interest rate can also increase the interest rates on savings accounts and CDs, although its implementation usually takes longer.
‘Strongly committed’ to 2% inflation target
The Fed’s move means that inflation has been at its fastest pace in more than 40 years. Central bank officials use the fund interest rate to try to slow down the economy – in this case to curb demand so that supply can catch up.
However, the statement after the meeting removed a long-used phrase indicating that the FOMC “expects inflation to return to the 2 per cent target and the labor market to remain strong.” The statement only noted that the Fed is “strongly committed” to the goal.
The political tightening is happening with economic growth that is already slowing down while prices are still rising, a condition known as stagflation.
Growth in the first quarter fell at a 1.5% annual pace, and an updated estimate on Wednesday from the Atlanta Fed, through its GDPNow tracker, set the second quarter flat. Two consecutive quarters of negative growth is a widely used rule of thumb to delineate a recession.
Fed officials engaged in a public handshake on Wednesday on Wednesday.
For several weeks, politicians had insisted that increases of half – or 50 basis points – could help stop inflation. In recent days, however, CNBC and other media have reported that conditions were ripe for the Fed to go beyond that. The changed approach came even though Powell in May had insisted that an increase of 75 basis points was not considered.
However, a recent series of alarming signals triggered the more aggressive action.
Inflation measured by the consumer price index rose 8.6% on an annual basis in May. The University of Michigan Consumer Survey reached an all-time low that included sharply higher inflation expectations. Retail sales figures published on Wednesday also confirmed that the most important consumer is weakening, with sales falling 0.3% for a month in which inflation rose 1%.
The labor market has been a strong point for the economy, although May’s increase of 390,000 was the lowest since April 2021. Average hourly earnings have increased in nominal terms, but adjusted for inflation it has fallen 3% over the past year.
The committee’s estimate, which was published on Wednesday, shows that unemployment, which is currently 3.6%, will increase to 4.1% by 2024.
All of these factors have combined to complicate Powell’s hopes for a “soft or soft” landing that he expressed in May. Interest rate tightening cycles in the past have often resulted in recessions.
Correction: Core PCE inflation ran at 4.9% in April. An earlier version misinterpreted the month.