The Fed is preparing the biggest rate hike in recent years: what you need to know

The Federal Reserve is going to deal its biggest blow in the fight against rising inflation.

Politicians begin a two-day meeting on Tuesday, and are expected to raise interest rates by half a percentage point – the biggest rate hike in more than two decades.

This is a clear indication of how fast the Fed is approaching inflation as prices continue to rise at the fastest pace in 40 years.

And the Fed won’t be done there. It is likely that the central bank will continue to raise borrowing prices in the coming months.

Here’s a brief look at the Fed’s battle plan.

Why is the Fed raising interest rates?

The central bank is concerned that prices are rising too fast as people continue to spend money ranging from buying things to booking long-delayed vacations.

Demand is so strong that it is ahead of what businesses can supply, given that global supply chains are still fragile and employers are still trying to find enough workers.

The key measure of the Ministry of Trade last week revealed prices rose 6.6% for 12 months ending in March. This is more than three times the Fed’s inflation target and the sharpest rise in prices since 1982.

The Fed hopes to suppress demand and ease inflation by making loans more expensive.

The The Fed has raised interest rates by a quarter of a percentage point in March, and this week is expected to see the first half increase since 2000.

Food prices rose when inflation peaked in four decades. (Frederick J. Brown / AFP via Getty Images)

By how much will the Fed raise interest rates?

Potentially much more.

Experts say interest rates may have to rise significantly to reduce demand after the Fed continued to borrow at its lowest level through much of the coronavirus pandemic.

On average, as Fed politicians said at their March meeting, rates will need to be raised almost 2 full percentage points this yearwith an additional rate hike next year.

Fed Chairman Jerome Powell said the central bank would closely monitor the economy and adjust the rate of increase if necessary.

But Powell believes the Fed’s usual practice of raising rates by a quarter of a point may not be enough. He believes that the central bank should act aggressively forward and then re-evaluate if necessary.

“In my opinion, it is advisable to move a little faster,” Powell said at a forum of the International Monetary Fund last month. “I also think there’s something in the idea of ​​front-loading any placement that you think is appropriate.”

How will rising borrowing costs affect the economy?

Rising interest rates make it more expensive to take out a car loan or carry a balance on a credit card.

They also increase the cost of buying a home. Mortgage rates already exist soared above 5% pending Fed action, up from less than 3% a year ago. This adds about $ 370 to the monthly payment for a house with an average price.

The intention of the Fed to raise rates is not to stimulate spending, enough to reduce inflation without subjecting the economy to recession – what economists call a “soft landing”.

“That’s our goal,” Powell said. “I don’t think you’ll hear anyone in the Fed say it’s going to be simple or easy.”

Some analysts are skeptical that the central bank can achieve this delicate balance by waiting until inflation rises so high.

They warn that aggressive action is now needed to control prices may cause an economic downturn. Deutsche Bank, a German lender and large Wall Street firm, last week predicted a “big recession” next year.

These concerns contributed to that last week sharp sales in the stock market.

Masked travelers at PHL airport
Masked travelers move near Terminal A at Philadelphia International Airport in Philadelphia, Tuesday, April 19, 2022 (AP Photo / Matt Rourke)

What other steps is the Fed taking?

In addition to raising interest rates, the Fed is expected to announce plans to gradually reduce the collection of government bonds and mortgage-backed securities it acquired during the pandemic.

Buying these bonds has helped pump money into the economy and keep borrowing costs low. Reducing the Fed’s holdings should have the opposite effect – lower demand and help curb inflation.

“It’s a secondary tool, but it removes quite a bit of liquidity and placement from the system,” said Katie Bostyancic of Oxford Economics.

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