On Wednesday, the Federal Reserve stepped up its fight against the worst inflation in 40 years, raising interest rates by a half-point — its most aggressive move since 2000 — and signaling further significant rate hikes.
The Fed raised key short-term interest rates from 0.75% to 1%, the highest level since the pandemic struck two years ago.
The Fed also announced that it would begin reducing its massive $9 trillion balance sheet, primarily comprised of Treasury and mortgage bonds. Reducing those holdings will result in higher borrowing costs throughout the economy.
At a press conference following the Fed’s most recent meeting, Federal Reserve Chair Jerome Powell said that the central bank’s officials understand the financial pain that high inflation is causing Americans.
However, Powell emphasized that the Fed is raising rates sharply for that very reason — to rein in high inflation, maintain the economy’s health, and alleviate the stress that millions of households are experiencing.
With food, energy, and consumer goods prices rising, the Fed’s goal is to cool spending and economic growth by making borrowing more expensive for individuals and businesses. The Fed hopes that higher mortgage, credit card, and auto loan rates will slow spending enough to keep inflation under control but not enough to cause a recession.
PBS reports this will be a delicate balancing act. The Fed has been widely chastised for being too slow to begin tightening credit, and many economists are skeptical that it can avoid causing a recession.
Powell stated at his news conference that he is confident that the economy is resilient enough to withstand higher borrowing rates. Job openings are at an all-time high. Each unemployed person has two available jobs on average. Wages are increasing at an unprecedented rate, and businesses continue to invest in equipment and software.
Powell also stated that more significant rate hikes are on the way. He said additional half-point increases in the Fed’s interest rates “should be on the table” in June and July meetings.
However, he sought to downplay speculation that the Fed was considering a rate hike of three-quarters of a percentage point.
The central bank’s policymakers noted that Russia’s invasion of Ukraine is exacerbating inflationary pressures by driving up food and oil prices. They went on to say that “COVID-related lockdowns in China are likely to exacerbate supply chain disruptions,” which could drive up prices even further.
According to the Fed’s preferred measure, inflation reached 6.6% last month, the highest level in four decades. It has been sped up by consistent consumer spending, chronic supply bottlenecks, and sharply increased gas and food prices.
Beginning June 1, the Fed announced that it would allow up to $48 billion in bonds to mature without replacement for three months, increasing to $95 billion by September. At the rate it was in September, its balance sheet would shrink by about $1 trillion per year. Following the pandemic recession, the Fed’s balance sheet doubled as it purchased trillions of dollars in bonds to keep long-term borrowing rates low.
Powell stated at the news conference that the Fed intends to raise its key rate “expeditiously” to a level that neither stimulates nor restrains economic growth, which the Fed estimates to be around 2.4%. The central bank’s policymakers have indicated that they will reach that point by year-end.
Economists warn that the Fed has no control over some factors driving inflation, such as supply and labor shortages.
On the other hand, Powell believes the Fed can cool soaring demand and thus help slow inflation.
The Fed’s tightening of credit is already impacting the economy. Existing-home sales fell 2.7% from February to March, reflecting a rise in mortgage rates caused by the Fed’s planned rate hikes. The average 30-year mortgage rate has risen by two percentage points since the beginning of the year to 5.1%.
Powell has cited widespread job availability as evidence that the labor market is “to an unhealthy level,” fueling inflation. The Fed chairman believes that raising interest rates will reduce job openings, slow wage growth, and ease inflationary pressures without causing mass layoffs.
For the time being, with the economy adding at least 400,000 jobs for 11 straight months and employers dealing with labor shortages, wages are rising at a 5% annual rate. Despite rising prices, wage increases are driving steady consumer spending. Even after adjusting for inflation, consumers increased their spending by 0.2% in March.
Financial markets are pricing at a Fed rate of up to 3.6% by mid-2023, the highest level in 15 years. The Fed’s balance sheet reduction will add another layer of uncertainty about how much the Fed’s actions will weaken the economy.
A slowdown in global growth complicates the Fed’s task. China’s COVID-19 lockdowns threaten to cause a recession in the world’s second-largest economy.
In addition, as a result of Russia’s invasion of Ukraine, the European Union is facing higher energy prices and supply chain disruptions.
Furthermore, other central banks worldwide are raising interest rates, putting global growth at risk.
WIVB 4 reports that the Bank of England expects to increase its key interest rate for the fourth time on Thursday. The Reserve Bank of Australia raised interest rates for the first time in 11 years on Tuesday.
Economists predict that the European Central Bank, dealing with slower growth than the U.S. or the UK, will raise interest rates in July.
