The Federal Reserve on Wednesday enacted its second consecutive 0.75 percentage point hike in interest rates as it seeks to rein in runaway inflation without creating a recession.
By raising the benchmark overnight borrowing rate to a range of 2.25% to 2.5%, the measures taken in June and July represent the toughest consecutive measure since the Fed began using the overnight rate as the main tool of monetary policy in the early 1990s.
While the federal funds rate has the most direct impact on what banks charge each other for short-term loans, it powers a host of consumer products such as adjustable mortgages, auto loans, and credit cards. credit. This increase brings the funds rate to its highest level since December 2018.
The markets widely expected this decision after Fed officials telegraphed the rise in a series of statements since the June meeting, and initially held the gains after the announcement. Central bankers have stressed the importance of bringing inflation down even if it means slowing the economy.
In his statement after the meetingthe Federal Open Market Committee responsible for setting rates warned that “recent spending and output indicators have softened.”
“Nevertheless, job gains have been robust in recent months and the unemployment rate has remained low,” the committee added, using language similar to the June statement. Officials again described inflation as “high” and attributed the situation to supply chain problems and rising food and energy prices, as well as “wider pressures on price”.
The the rate hike was unanimously approved. In June, Kansas City Fed President Esther George dissented, advocating a slower course with a half-percentage-point hike.
The increases come in a year that started with rates hovering around zero but saw a measure of inflation at 9.1% per year. The Fed is aiming for inflation of around 2%, although it has adjusted that target in 2020 to allow it to warm up a bit in the interest of inclusive full employment.
In June, the unemployment rate maintained at 3.6%, close to full employment. But inflation, even by the Fed’s standard for core personal consumption expenditure, which was 4.7% in May, is way off target.
Efforts to bring down inflation are not without risks. The U.S. economy is on the brink of recession as inflation slows consumer shopping and slows business activity.
First-quarter GDP fell 1.6% annualized, and markets were bracing for a second-quarter reading to be released on Thursday that could show back-to-back declines, a widely used barometer for a recession. The Dow Jones estimate for Thursday’s reading is for 0.3% growth.
Along with the rate hikes, the Fed is reducing the size of assets held on its balance sheet by nearly $9 trillion. Beginning in June, the Fed began allowing the transfer of a portion of the proceeds from maturing bonds.
The balance sheet has shrunk by only $16 billion since the start of the roll-off, although the Fed has set a cap of up to $47.5 billion that could potentially have been reduced. The cap will increase throughout the summer, eventually reaching $95 billion per month by September. The process is known in the markets as “quantitative tightening” and is another mechanism the Fed uses to influence financial conditions.
Along with accelerated balance sheet liquidation, markets expect the Fed to hike rates by at least another half-percentage point in September. As of Wednesday afternoon, traders were assigning about a 53% chance of the central bank going even further, with a third straight increase of 0.75 percentage points, or 75 basis points, in September, according to data from the CME Group. .
The FOMC does not meet in August, but officials will meet in Jackson Hole, Wyoming, for the annual Fed retreat.
Markets expect the Fed to start cutting rates by next summer, even though the committee’s projections released in June show no cut until at least 2024.
Several officials have said they expect an aggressive hike through September and then assess the impact of these measures on inflation. Despite the increases – totaling 1.5 percentage points between March and June – June’s consumer price index reading was the highest since November 1981, the rent index at its highest level since April 1986 and dental care costs hitting an all-time high in a data series dating back to 1995.
The central bank has been criticized, both for being too slow to tighten when inflation started to pick up in 2021, and for possibly going too far and causing a more severe economic downturn.