Federal Reserve System Officials, struggling to contain the fastest inflation in 40 years, made their third super-sized rate hike in a row on Wednesday, forecasting a more aggressive monetary policy path that will push interest rates higher and keep them higher for longer.
The Fed raised its policy interest rate by three quarters of a percentage point, increasing it to a range of 3 to 3.25 percent. That’s a significant jump from as recently as March, when the federal funds rate was set near zero, and the hike since then has led to the Fed’s fastest policy adjustment since the 1980s.
Even more remarkable are the politicians he predicted on Wednesday that they will increase borrowing costs to 4.4 percent by the end of the year and are predicting significantly higher interest rates in the coming years than they originally expected. Jerome H. Powell, the Fed chairman, warned that the moves would be painful for the U.S. economy — but said curbing growth to limit price increases was essential.
“We have to get inflation behind us,” Mr. Powell said during his press conference after the meeting. “I wish there was a painless way to do it; it’s not.”
Together, the Fed’s dovish projections and the Fed chairman’s comments led to a statement: The central bank is committed to curbing inflation, even if it comes at a cost to the economy in the near term. The news hit the markets, which fell in response to the news S&P 500 close a decrease of 1.7 percent.
“We want to act aggressively now, get this job done and continue to do it until it’s done,” Mr. Powell explained.
His stark remarks reflect a tough reality for the Fed. Inflation was stubbornly rapid and proved difficult to bring under control.
Prices continue to rise to more than three times the central bank’s target rate of 2 percent, making daily living harder to achieve as everything from rent to food to household goods continues to become more expensive. The spike in inflation, which is being felt globally, stems in part from supply chain disruptions caused by the pandemic and the war in Ukraine. But pricing pressures also come from sustained consumer demand, which has allowed companies to charge more without losing customers.
In fact, people continued to buy cars, retail goods and dinner even as the central bank began to sharply raise interest rates. Companies continue to rake in big profits while hiring quickly, raising wages as they compete for scarce workers — and sending prices relentlessly higher.
The Fed is trying to change that, the central bank made clear Wednesday.
“It’s consistent with the message that inflation is public enemy No. 1: It must continue,” said Priya Misra, head of global rates research at TD Securities.
What the Fed rate hike means for you
Fed policy works by curbing demand. Higher interest rates make it more expensive to borrow money to buy a car or house or to expand a business, slowing consumer spending and corporate expansion. As the economy cools and hiring and wage growth slows, companies will struggle to charge their customers as much money, setting the stage for more muted price increases.
Therefore, the path to weaker inflation is likely to be painful. Officials predicted unemployment would rise to 4.4 percent next year — more than 3.7 percent now – and stay there until 2024 as economic growth falls well below its potential.
“That’s something we think we need,” Mr. Powell said. “We think we need to have softer conditions in the labor market as well.”
Fed officials believe the cost is worth it. Leaving inflation unchecked could allow it to become a more permanent feature of the economy. If workers begin to expect prices to rise sharply year after year, they are likely to demand faster wage increases. Businesses would most likely pass these costs on to customers in the form of higher prices, creating an unhealthy upward spiral.
If inflation were to become commonplace in everyday economic life, it might become harder to suppress. The Fed allowed uncomfortably rapid inflation to continue throughout the 1970s and subsided only after the Fed, under then-Chairman Paul Volcker, pushed interest rates to double digits in the 1980s, sending unemployment soaring to 10 percent.
Many economists believe that the drastic response was necessary because inflationary psychology took hold. No one wants to repeat the experience.
In the 1970s, the Fed’s attempts to raise rates did not go far enough and “were not enough to reduce inflation,” said William English, a former director of the Fed’s monetary affairs division who is now an economist at Yale University.
“That’s what they want to avoid,” he said. “At the end of the day, higher inflation is not acceptable – you’re going to have to lower it.”
But to reduce growth enough to tame rising prices, officials believe rates will have to rise significantly. Their forecasts for 2022 suggest that rates could rise by three-quarters of a point at the next meeting and then by half a point at the Fed’s December meeting. That’s higher than many on Wall Street expected ahead of the meeting, and a lot more action than what markets bet on just a few weeks ago.
And the politicians plan to continue. Central bankers now expect borrowing costs to rise to 4.6 percent by the end of 2023, their fresh projections showed, up from an estimate of 3.8 percent in June. Fed officials expect to begin cutting rates in 2024, but they anticipate cutting rates slowly.
As central bankers prepare to push rates to levels not seen before the 2008 financial crisis, Ms Misra said she was surprised they did not anticipate even higher unemployment.
Unemployment rising to 4.4 percent, as central bankers have predicted, would be undeniably painful. Omair Sharif, founder of Inflation Insights, calculated that this would mean roughly 1.4 million more unemployed people. But it would be relatively moderate given the extent of the tightening that the central bank is planning. In the 2008 recession unemployment rose to 10 percent.
Acknowledging that, Mr Powell said officials hoped emerging supply chain improvements and large job vacancies would give the economy a buffer to cool inflation without putting many people out of work.
Markets briefly appeared to take these unemployment projections as a sign that the Fed might not act drastically and avoid fueling the economy and asset prices. As Mr. Powell spoke, stock prices briefly jumped. But they eventually fell again as investors digested his broader message: While the Fed may be bullish in its projections, it is determined to fight inflation lower even if its hopes don’t pan out.
“It would be nice if there was a way to just wish it away, but there isn’t,” Mr. Powell said of inflation. “We have to get supply and demand back in line, and the way we do that is by slowing the economy.”
The somber tone was a subtle but important shift for Mr. Powell. The Fed chairman has emphasized the bright side of the economic story in the past — frequently highlighting reasons last year why inflation could be short-lived and earlier this year citing reasons why the Fed might be able to achieve a soft landing. which inflation declines without a recession.
But he explained on Wednesday that while there are reasons to hope that the labor market fallout from higher rates may not be extremely painful, “in any case, our job is to ensure price stability.”
When asked about housing, he explained that a painful correction may be needed to rebalance the market. And when asked about shelter inflation pushing overall price increases higher, he stressed that it could remain high for some time.
“I’m hoping for the best,” Mr. Powell said. “Plan for the worst.”