The Federal Reserve on Wednesday launched its biggest fallout yet against inflation, raising benchmark interest rates by three-quarters of a percentage point in a move equivalent to the most violent hike since 1994.
After weeks of speculation, the rate-setting Federal Open Market Committee raised its funds rate to a range of 1.5%-1.75%, the highest level since before the start of the Covid pandemic in March 2020.
Stocks were volatile after the decision but turned higher as Federal Reserve Chairman Jerome Powell spoke at his post-meeting press conference.
“Obviously, a 75 basis point increase is an extraordinarily large increase, and I don’t expect moves of this magnitude to be common,” Powell said. But he added that he expects the July meeting to see an increase of 50 or 75 basis points. He said decisions would be made “meeting by meeting” and the Fed would continue to “communicate our intentions as clearly as possible.”
“We want to see progress,” Powell said. “Inflation cannot go down until it stabilizes.” “If we don’t see progress… it may cause us to react. Soon we will see some progress.”
Members of the Federal Open Market Committee have indicated a much stronger path for price increases in the future to stem inflation moving at the fastest pace going back to December 1981, according to one commonly cited measure.
The Fed’s benchmark interest rate will end the year at 3.4%, according to the midpoint of the target range of individual members’ expectations. That compares to an upward revision of 1.5 percentage points from the March estimate. The committee then sees the rate rising to 3.8% in 2023, a full percentage point higher than projected in March.
Reducing growth forecasts in 2022
Officials have also dramatically lowered their economic growth forecast for 2022, and now expect an increase of just 1.7% in gross domestic product, down from 2.8% from March.
Inflation expectations according to personal consumption expenditures also rose to 5.2% this year from 4.3%, despite reference to core inflation, which excludes a rapid rise in food and energy costs, at 4.3%, just 0.2 percentage points higher than the previous forecast. Core PCE inflation came in at 4.9% in April, so Wednesday’s forecast expects price pressures to ease in the coming months.
The committee’s statement painted a largely optimistic picture of the economy even with inflation rising.
“General economic activity appears to have rebounded after declining in the first quarter,” the statement said. “Job gains have been solid in recent months, and the unemployment rate has remained low. Inflation remains high, reflecting supply and demand imbalances linked to the pandemic, higher energy prices, and broader price pressures.”
In fact, estimates expressed through the committee’s Summary of Economic Outlook are for inflation to fall sharply in 2023, to 2.6% headline and 2.7% headline, expectations are little changed from March.
In the longer term, the committee’s outlook for policy largely matches market expectations that see a series of increases ahead that will raise the money rate to about 3.8%, its highest level since late 2007.
The statement was approved by all FOMC members except for Kansas City Bank President Esther George, who favored a smaller half-point increase.
Banks use the rate as a benchmark for what they charge each other for short-term borrowing. However, it feeds directly through many consumer debt products, such as adjustable rate mortgages, credit cards, and auto loans.
The money rate can also drive up the prices of savings accounts and CDs, although feeding through this generally takes longer.
‘Hardly committed’ to 2% inflation target
The Fed’s move comes as inflation rises at its fastest pace in more than 40 years. Central bank officials use the interest rate to try to slow the economy – in this case to curb demand so that supply can catch up.
However, the post-meeting statement removed a long-used phrase that the FOMC “expects inflation to return to its 2 percent target and the labor market to remain strong.” The statement only indicated that the Fed was “strongly committed” to this goal.
Policy tightening occurs as economic growth is already slowing while prices are still rising, a condition known as stagflation.
First-quarter growth slid at a 1.5% annualized pace, and an updated estimate Wednesday from the Atlanta Federal Reserve, through its GDP tracker Now, put the second quarter flat. Two consecutive quarters of negative growth is a widely used rule of thumb for defining a recession.
Fed officials engaged in a public fit of tension ahead of Wednesday’s decision.
For weeks, policymakers have been insisting that half-point – or 50 basis point – increases could help stem inflation. In recent days, though, CNBC and other media outlets have reported that conditions are ripe for the Federal Reserve to move past this. The changed approach came even though Powell agreed in May that hiking 75 bps was not considered.
However, a recent string of alarming signals has led to more aggressive action.
Inflation as measured by the Consumer Price Index rose 8.6% y/y in May. The University of Michigan consumer opinion poll hit an all-time low that included sharply higher inflation expectations. Also, Wednesday’s retail sales figures confirmed the critical consumer is weakening, with sales down 0.3% for the month when inflation rose 1%.
The job market has been a strong point for the economy, although May’s gain was the lowest since April 2021. Average hourly earnings were rising in nominal terms, but when adjusted for inflation, it’s down 3% over the past year.
The committee’s forecast released on Wednesday points to a rise in the unemployment rate, currently at 3.6%, to 4.1% by 2024.
All of these factors have combined to complicate Powell’s hopes of a “soft or quiet” landing, which he expressed in May. Price tightening cycles in the past have often been in recessions.
Correction: Core PCE inflation registered 4.9% in April. Previous version missed a month.