WASHINGTON (AP) — The Federal Reserve raised its benchmark interest rate by three-quarters of a point on Wednesday for the second straight time in its most aggressive campaign in three decades to rein in high inflation.
The Fed’s decision will raise its key rate, which affects many consumer and business loans, to a range of 2.25% to 2.5%, its highest level since 2018.
The central bank’s decision follows a jump in inflation to 9.1%, the fastest annual rate in 41 years, and reflects its strenuous efforts to slow rising prices across the economy. By raising borrowing rates, the Fed is making it more expensive to take out a mortgage or car or business loan. Consumers and businesses are likely to borrow and then spend less, which cools the economy and slows inflation.
The Fed is tightening credit even as the economy has begun to slow, increasing the risk that its rate hikes will trigger a recession later this year or next. The surge in inflation and the fear of a recession have eroded consumer confidence and restless public concern about the economy, who sends frustrating mixed signals.
“I don’t think the United States is currently in a recession,” President Jerome Powell said at a press conference on Wednesday.
As November’s midterm elections approach, American discontent has eased President Joe Biden’s approval ratings and increased the likelihood of Democrats losing control of the House and Senate.
The measures taken by the Fed to tighten credit sharply have torpedoed the housing market, which is particularly sensitive to changes in interest rates. The average 30-year fixed mortgage rate has roughly doubled over the past year, to 5.5%, and home sales have fallen.
At the same time, consumers are showing signs of spending cuts in the face of high prices. And business surveys suggest sales are slowing.
The central bank is betting it can slow growth just enough to bring inflation under control, but not so much as to trigger a recession – a risk many analysts fear will end badly.
In a statement released by the Fed after the end of its last policy meeting, it acknowledged that while “spending and output indicators have weakened”, “jobs gains have been robust in recent months and the rate of unemployment remained low. The Fed typically places a premium on the pace of hiring and wage growth, because when more people earn paychecks, the resulting spending can fuel inflation.
Ian Shepherdson of Pantheon Macroeconomics noted this point, saying: “The Fed is not ready – yet – to admit that weaker growth is a reason to slow the pace of tightening”,
When the government estimates gross domestic product for the April-June period on Thursday, some economists believe it could show the economy has contracted for a second straight quarter. This would answer a long held assumption about the onset of a recession.
But economists say would not necessarily mean that a recession has started. In those same six months when the overall economy might have contracted, employers added 2.7 million jobs — more than in most entire years before the pandemic. Wages are also rising at a healthy pace, with many employers still struggling to attract and retain enough workers.
Yet slowing growth puts Fed policymakers in a high-risk dilemma: How much should they raise borrowing rates if the economy slows? Lower growth, if it causes layoffs and increases unemployment, often reduces inflation on its own.
This dilemma could become even more important for the Fed next year, when the economy could be in worse shape and inflation is likely to still exceed the central bank’s 2% target.
“How much recession risk are you willing to bear to bring (inflation) down to 2%, quickly, over several years? asked Nathan Sheets, a former Fed economist who is chief global economist at Citi. “Those are the kinds of issues they’re going to have to grapple with.”
Bank of America economists forecast a “mild” recession later this year. Goldman Sachs analysts estimate a 50-50 probability of a recession within two years.
Among analysts who forecast a recession, most predict that it will be relatively mild. The unemployment rate, they note, is near a 50-year low and households are generally in good financial health, with more cash and lower debt than after the housing bubble burst in 2008. .
Fed officials have hinted that at its new level, its short-term policy rate will neither stimulate nor restrain growth – what they call a “neutral” level. Powell said the Fed wants its policy rate to reach neutral relatively quickly.
If the economy continues to show signs of slowing, the Fed could moderate the extent of its rate hikes at its next meeting in September, perhaps by half a point. Such an increase, followed by possible quarter-point hikes in November and December, would take the Fed’s short-term rate further to 3.25% to 3.5% by the end of the year – the highest point since 2008.