Fed attacks inflation with its largest rate hike since 1994

WASHINGTON (AP) — The Federal Reserve intensified its fight against
high inflation on Wednesday, raising its key interest rate by
three-quarters of a point — the largest bump since 1994 — and
signaling more rate hikes ahead as it tries to cool off the U.S.
economy without causing a recession.

The unusually large rate hike came after data released Friday showed
U.S. inflation rose last month to a four-decade high of 8.6% — a
surprise jump that made financial markets uneasy about how the Fed
would respond. The Fed’s benchmark short-term rate, which affects many
consumer and business loans, will now be pegged to a range of 1.5% to
1.75% — and Fed policymakers forecast a doubling of that range by
year’s end.

“We thought strong action was warranted at this meeting, and we
delivered that,” Fed Chair Jerome Powell said at a news conference in
which he stressed the central bank’s commitment to do what it takes to
bring inflation down to the Fed’s target rate of 2%. Getting to that
point, he said, might result in a slightly higher unemployment rate as
economic growth slows.

Powell said it was imperative to go bigger than the half-point
increase the Fed had earlier signaled because inflation was running
hotter than anticipated — causing particular hardship on low-income
Americans. Another concern is that the public is increasingly
expecting higher inflation in the future, which can become a
self-fulfilling prophecy by accelerating spending among consumers
seeking to avoid rising prices for certain goods.

The central bank revised its policy statement to acknowledge that its
efforts to quell inflation won’t be painless, removing the previous
language that had said Fed officials expect “the labor market to
remain strong.”

“It’s going to be a far bumpier ride to get inflation down than what
they had anticipated previously,” said Matthew Luzzetti, chief U.S.
economist at Deutsche Bank.

Fed officials forecast unemployment ticking up this year and next,
reaching 4.1% in 2024 — a level that some economists said would risk a
recession.

Yet Powell largely stuck to his previous reassurances that — with
unemployment near a five-decade low, wages rising, and consumers’
finances mostly solid — the economy can withstand higher interest
rates and avoid a recession.

“We’re not trying to induce a recession now,” he said. “Let’s be clear
about that. We’re trying to achieve 2% inflation.”

Powell said that another three-quarter-point hike is possible at the
Fed’s next meeting in late July if inflation pressures remain high,
although he said such increases would not be common.

Some financial analysts suggested Powell struck the right balance to
reassure markets, which rallied on Wednesday. “He hit it hard that ‘we
want to get inflation down’ but also hit hard that ‘we want a soft
landing,’ ” said Robert Tipp, chief investment strategist at PGIM
Fixed Income.

Still, the Fed’s action on Wednesday was an acknowledgment that it’s
struggling to curb the pace and persistence of inflation, which is
being fueled by strong consumer spending, pandemic-related supply
disruptions, and soaring energy prices that have been aggravated by
Russia’s invasion of Ukraine.

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 has sought to show he recognizes the pain that inflation is
causing American households but has struggled to find policy actions
that might make a real difference. The president has stressed his
belief that the power to curb inflation rests mainly with the Fed.

Yet the Fed’s rate hikes are blunt tools for trying to lower inflation
while also sustaining growth. Shortages of oil, gasoline, and food are
contributing to higher prices. Powell said several times during the
news conference that such factors are out of the Fed’s control and may
force it to push rates even higher to ultimately bring down inflation.

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 5%, its highest level since before the 2008
financial crisis, up from just 3% at the start of the year.

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.

Over the next two years, the officials are forecasting a much weaker
economy than was envisioned in March. They forecast growth will be
1.7% this year and next. That’s below their outlook in March but
better than some economists’ expectation for a recession next year.

Even if the Fed manages the delicate trick of curbing inflation
without causing a downturn, higher rates will nevertheless inflict
pressure on stocks. The S&P 500 has already sunk more than 20% this
year, meeting the definition of a bear market.

On Wednesday, the S&P 500 rose 1.5%. The two-year Treasury yield fell
to 3.23% from 3.45% late Tuesday, with the biggest move happening
after Powell said not to expect three-quarter percentage point rate
hikes to be common.

Other central banks are also acting to try to quell inflation, even
with their nations at greater risk of recession than the U.S.

The European Central Bank is expected to raise rates by a
quarter-point in July, its first increase in 11 years. It could
announce a larger hike in September if record-high levels of inflation
persist. On Wednesday, the ECB vowed to create a market backstop that
could buffer member countries against financial turmoil of the kind
that erupted during a debt crisis more than a decade ago.

The Bank of England has raised rates four times since December to a
13-year high, despite predictions that economic growth will be
unchanged in the second quarter. The BOE will hold an interest rate
meeting on Thursday.

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