WASHINGTON (AP) — Stepping up its fight against high inflation, the Federal Reserve raised its key interest rate by a significant three-quarters of a point on Wednesday for the third straight time and signaled more big rate hikes — an aggressive pace that will increase the risk of an eventual recession.
The Fed’s move raised its benchmark short-term rate, which has an impact many consumer and business loansto a range of 3% to 3.25%, the highest level since early 2008.
Officials also forecast they will raise the base rate further to around 4.4% by the end of the year, a full percentage point higher than they predicted back in June. And they expect to raise the rate next year to about 4.6%. This would be the highest level since 2007.
On Wall Street, stock prices fell and bond yields rose in response to the Fed’s predictions of further sharp rate hikes.
The central bank’s action on Wednesday followed a government report last week showed that high costs are spread more widely across the economy, with spikes in the cost of rent and other services worsening even as some of the previous drivers of inflation, such as gas prices, have eased. By raising borrowing rates, the Fed makes it more expensive to get a mortgage, car loan, or business loan. Consumers and businesses then presumably borrow and spend less, cooling the economy and slowing inflation.
Fed officials said they were looking for a “soft landing” that would allow them to slow growth enough to curb inflation but not enough to trigger a recession. Still, economists are increasingly saying they think the Fed’s sharp rate hikes will eventually lead to job cuts, higher unemployment and a full-blown recession late this year or early next year.
In their updated economic outlook, Fed officials forecast that economic growth will remain weak over the next few years as unemployment rises. The unemployment rate is expected to reach 4.4% by the end of 2023, compared to the current level of 3.7%. Historically, economists say, whenever the unemployment rate has risen by half a point in a few months, a recession has always followed.
Fed officials now see the economy growing just 0.2% this year, well below the 1.7% forecast just three months ago. And growth is expected to slow below 2% from 2023 to 2025.
And even with the sharp rate hike the Fed envisions, it still expects core inflation — excluding the volatile food and gas categories — to be 3.1% at the end of next year, well above its 2% target.
Speaker Jerome Powell acknowledged this in a speech last month Fed moves ‘will hurt’ for households and businesses. And he added that the central bank’s commitment to reduce inflation to the 2% target was “unconditional”.
Falling gas prices have slightly dampened overall inflation, which was still a painful 8.3% in August compared to a year earlier. Perhaps this was facilitated by the decrease in gas prices the recent increase in President Joe Biden’s public approval ratingswhich Democrats hope will boost their prospects in November’s midterm elections.
Short-term rates at the level the Fed is now projecting would make a recession more likely next year by sharply increasing the cost of mortgages, auto loans and business loans. The economy hasn’t seen rates as high as the Fed predicts since the 2008 financial crisis. The average fixed mortgage rate topped 6% last week, a 14-year high. The cost of credit card loans has reached its highest level since 1996 Bankrate.com.
Inflation now appears to be driven more by rising wages and sustained consumer spending, and less by the supply shortages that plagued the economy during the pandemic recession. However, Biden told CBS’ “60 Minutes” on Sunday that he believes a soft landing for the economy is still possible, suggesting that his administration’s recent energy and health care legislation will lower drug and health care prices.
Some economists are beginning to worry that the Fed’s rapid rate hike — the fastest since the early 1980s — will do more economic damage than is necessary to tame inflation. Mike Konchal, an economist at the Roosevelt Institute, noted that the economy is already slowing and that wage growth — a key driver of inflation — is leveling off and, by some measures, even declining slightly.
Polls also show that Americans expect inflation to ease significantly over the next five years. This is an important trend because inflationary expectations can become self-fulfilling: if people expect inflation to ease, some will feel less pressure to speed up their purchases. In that case, lower costs will help keep prices from rising.
Chancellor said there is a case for the Fed to slow rate hikes over the next two meetings.
“Given the rapid cooling,” he said, “you don’t want to rush it.”
The Fed’s rapid rate hike mirrors steps taken by other major central banks, fueling fears of a potential global recession. The European Central Bank last week raised the base rate by three quarters of a percentage point. The Bank of England, the Reserve Bank of Australia and the Bank of Canada have raised rates significantly in recent weeks.
And in China, the world’s second-largest economy, growth is already suffering from repeated government COVID lockdowns. If a recession hits most major economies, it could derail the US economy as well.
Even with the accelerated pace of Fed rate hikes, some economists — and some Fed officials — argue that they have yet to raise rates to a level that would effectively limit borrowing and spending and slow growth.
Many economists are convinced that mass layoffs will be needed to slow the rise in prices. A study published earlier this month by the Brookings Institution concluded that the unemployment rate could reach 7.5% to bring inflation back to the Fed’s 2% target.
According to a study by Johns Hopkins University economist Lawrence Ball and two economists at the International Monetary Fund, only such a sharp decline could reduce the growth of wages and consumer spending enough to cool inflation.