Fed: Sharply higher rates may be needed to quell inflation

Federal Reserve officials were concerned at their meeting last month
that consumers were increasingly anticipating higher inflation, and
they signaled that much higher interest rates could be needed to
restrain it.

The policymakers also acknowledged, in minutes from their June 14-15
meeting released Wednesday, that their rate hikes could weaken the
economy. But they suggested that such steps were necessary to slow
price increases back to the Fed’s 2% annual target.

The officials agreed that the central bank needed to raise its
benchmark interest rate to “restrictive” levels that would slow the
economy’s growth and “recognized that an even more restrictive stance
could be appropriate” if inflation persisted. After last month’s
meeting, the Fed raised its key rate by three-quarters of a point to a
range of 1.5% to 1.75% — the biggest single increase in nearly three
decades — and signaled that further large hikes would likely be
needed.

The Fed has been ramping up its drive to tighten credit and slow
growth with inflation having reached a four-decade high of 8.6%,
spreading to more areas of the economy. Americans are also starting to
expect high inflation to last longer than they had before — a
sentiment that could embed inflationary psychology and make it harder
to slow price increases.

And with midterm elections nearing, high inflation has surged to the
top of Americans’ concerns, posing a threat to President Joe Biden and
Democrats in Congress.

At a news conference after last month’s Fed meeting, Chair Jerome
Powell suggested that a rate hike of either one-half or three-quarters
of a point was likely when the policymakers next meet late this month.
The minutes released Wednesday confirmed that other officials agreed
that such an increase would “likely be appropriate.” A rate hike of
either size would exceed the quarter-point increase that the Fed has
typically carried out.

Last month, the Fed released projections that showed that the
officials expect to raise their benchmark rate to 3.4% by the end of
this year. At that level, the Fed’s key rate would no longer stimulate
growth and could weaken the economy. The minutes suggest that the
policymakers could potentially raise rates above that level.

At the time of last month’s meeting, the policymakers said the economy
appeared to be expanding in the April-June quarter, with consumer
spending “remaining strong.” Since then, though, the economy has shown
signs of slowing, with consumer spending falling in May, after
adjusting for inflation, for the first time this year. Home sales are
plunging as mortgage rates have jumped, accelerated by the Fed’s rate
increases.

The signs of economic sluggishness have intensified fears that high
prices and rising rates could send the economy into a recession late
this year or next year. Such concern has further complicated the Fed’s
policymaking because a recession would normally lead it to cut rates
to stimulate growth.

Some economists described the Fed’s assessment of the economy, as laid
out in Wednesday’s minutes, as outdated even though it is only three
weeks old. Prices for oil, wheat, and other commodities are falling,
wage gains are moderating and growth is slowing. Those trends may mean
that the Fed’s policymakers, who have said they will be “nimble” in
responding to economic data, won’t raise rates as fast as financial
markets expect.

“We very much hope that the sobering data since the June meeting will
push members towards the smaller hike,” of a half-point rather than
three-quarters in July, said Ian Shepherdson, chief economist at
Pantheon Macroeconomics. “They wanted to send a clear signal that they
will not accommodate permanently higher inflation, but that job is
done.”

The Fed had been expected to raise rates by a half-point at last
month’s meeting but ended up announcing a three-quarter point hike
instead. At his news conference afterward, Powell mentioned recent
economic reports that had heightened concerns about high inflation.
Those reports included inflation data for May, which showed that the
pace of price increases reached a 40-year high.

Powell also cited a survey of consumer sentiment conducted by the
University of Michigan that said consumers’ longer-term inflation
expectations were starting to rise more quickly. That unnerved Powell
and other Fed officials because if people expect higher inflation,
that sentiment can lead to an acceleration of prices. Workers could,
for example, demand higher pay to cover their expectation of rising
bills and expenses, leading companies, in turn, to raise prices
further to offset their higher labor costs.

The Fed is seeking to convince the public that it will rise to the
challenge and tame the pace of price increases, with the goal of
keeping Americans’ inflation expectations in check.

There is “a significant risk now facing the (Fed) that elevated
inflation could become entrenched if the public began to question the
resolve” of Fed officials to combat higher prices, the minutes said.

As a result, the minutes said, tighter credit and “clear and effective
communications” are critical to controlling inflation.

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