The US Federal Reserve attacks inflation with another big hike and expects more

Christopher Rogaber, Associated Press

Published Wednesday, September 21, 2022 2:40 PM EST

Last update Wednesday, September 21, 2022 3:39PM EST

Washington (AFP) – Intensifying its fight against high inflation, the Federal Reserve raised its key interest rate on Wednesday by three-quarters of a large point for the third time in a row and signaled more significant rate increases ahead – a solid pace that will raise the risk of a recession in end of the day.

The Fed’s move boosted the benchmark short-term interest rate, which affects many consumer and business loans, to a range of 3% to 3.25%, the highest level since early 2008.

Officials also predicted that they would raise their benchmark rate to nearly 4.4% by the end of the year, a full point higher than they had expected as recently as June. They expect to raise the rate next year as well to around 4.6%. This will be the highest level since 2007.

By raising borrowing rates, the Federal Reserve makes it more expensive to obtain a mortgage, car or business loan. Consumers and businesses are then supposed to borrow and spend less, cooling the economy and slowing inflation.

Lower gas prices slightly lowered headline inflation, which was still a painful 8.3% in August compared to a year earlier. Lower gas prices may have contributed to the recent spike in President Joe Biden’s public approval ratings, which Democrats hope will boost their prospects in the November midterm elections.

Speaking at a press conference, Chairman Jerome Powell said that before Fed officials would consider halting rate hikes, they “want to be very confident that inflation will come back down” to their 2% target. He pointed out that the strength of the labor market fuels wage gains that help to raise inflation.

He stressed his belief that curbing inflation is necessary to ensure the long-term health of the labor market.

Powell said, “If we want to light the way to another period of a very strong labor market, we have to get inflation behind us. I wish there was a painless way to do it. There isn’t.”

Federal Reserve officials said they are seeking a “soft landing,” in which they can slow growth enough to tame inflation but not so much as to trigger a recession. However, most economists say they believe that sharp rate increases by the Fed will, over time, lead to job cuts, increased unemployment, and a full-blown recession late this year or early next.

“No one knows if this process will lead to a recession, or if so, how important that recession will be,” Powell said at his press conference. “It will depend on how quickly inflation is reduced.”

In their updated economic forecasts, Fed policymakers predict that economic growth will remain subdued over the next few years, with unemployment rates rising. It expects the unemployment rate to reach 4.4% by the end of 2023, up from its current level of 3.7%. Historically, economists say, any time the unemployment rate rose by half a point over several months, a recession always followed.

Federal Reserve officials now expect the economy to expand by just 0.2% this year, sharply lower than their forecast of 1.7% growth just three months ago. They envision slow growth of less than 2% from 2023 through 2025.

Even with the sharp rate hikes the Fed expects, it still expects core inflation – which excludes volatile food and gas categories – to be 3.1% at the end of next year, well above its 2% target.

Powell admitted in a speech last month that the Fed’s moves would “bring some pain” to households and businesses. He added that the central bank’s commitment to reduce inflation to the 2% target was “unconditional”.

Short-term rates at the level the Fed now imagines would make a recession more likely next year by sharply raising the costs of mortgages, auto loans and business loans. The economy has not seen rates as high as the Fed expects since before the 2008 financial crisis. Last week, the average fixed-rate mortgage rate exceeded 6%, its highest level in 14 years. Credit card borrowing costs are at their highest level since 1996, according to Bankrate.com.

Inflation now appears to be increasingly fueled by rising wages and consumers’ constant desire to spend and to a lesser extent by the lack of supplies that crippled the economy during the pandemic recession. However, Biden said Sunday on CBS’ “60 Minutes” that he believes an easy landing for the economy is still possible, suggesting that his recent energy and health care administration’s legislation will lower drug and health care prices.

The law may help bring down prescription drug prices, but outside analyzes suggest it will do little to bring down headline inflation immediately. Last month, the nonpartisan Congressional Budget Office opined that it would have a “negligible” effect on prices through 2023. Ben Wharton’s budget model at the University of Pennsylvania went so far as to say that “the effect on inflation is statistically indistinguishable from zero” during the next decade.

However, some economists are beginning to express concern that rapid increases in federal interest rates – the fastest since the early 1980s – will do too much economic damage to tame inflation. Mike Konzal, an economist at the Roosevelt Institute, has noted that the economy is already slowing and that wage increases – the main driver of inflation – are stabilizing and some measures are falling.

Surveys also show that Americans expect inflation to drop significantly over the next five years. This is an important trend because inflation expectations can be self-fulfilling: if people expect inflation to fall, some will feel less pressure to speed up their purchases. Less spending would help moderate price increases.

Rapid interest rate increases by the Federal Reserve mirror the steps other major central banks are taking, contributing to concerns about a possible global recession. Last week, the European Central Bank raised its benchmark interest rate by three-quarters of a percentage point. The Bank of England, the Reserve Bank of Australia and the Bank of Canada have all raised interest rates significantly in recent weeks.

And in China, the world’s second-largest economy, growth is already suffering from repeated government shutdowns of the coronavirus. If a recession engulfs most of the big economies, it could derail the US economy as well.

Even with the Fed’s accelerating rate of rate hikes, some economists – and some Fed officials – argue that they have not yet raised rates to a level that will constrain borrowing and spending and slow growth.

Many economists seem convinced that large-scale layoffs will be necessary to slow price increases. Research published earlier this month sponsored by the Brookings Institution concluded that unemployment may have to rise to 7.5% to bring inflation back to the Fed’s 2% target.

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