The Federal Reserve kicked off its biggest inflation campaign yet on Wednesday, raising benchmark interest rates by three-quarters of a percentage point in a move that equaled the most aggressive hike since 1994.
Ending weeks of speculation, the Federal Open Market Committee responsible for setting rates raised the level of its benchmark funds rate to a range of 1.5% to 1.75%, the highest since just before the start of the Covid pandemic in March 2020.
Stocks were volatile after the decision but rose when Fed Chairman Jerome Powell spoke at his post-meeting press conference.
“Obviously today’s 75 basis point increase is unusually large, and I don’t expect moves of this magnitude to be common,” Powell said. He added, however, that he expects the July meeting to see an increase of 50 or 75 basis points. He said decisions will be made “meeting by meeting” and the Fed will “continue to communicate our intentions as clearly as possible.”
“We want to see progress. Inflation can’t come down until it stabilizes,” Powell said. “If we don’t see progress…it could make us react. Soon we will see progress.”
FOMC members pointed to a much stronger trajectory of rate hikes ahead to stop inflation at its fastest pace since December 1981, according to a commonly cited measure.
The Fed’s benchmark rate will end the year at 3.4%, based on the midpoint of members’ individual expectations target range. That compares to an upward revision of 1.5 percentage points from the March estimate. The committee then sees the rate rising to 3.8% in 2023, a percentage point higher than what was forecast in March.
2022 growth outlook revised downwards
Officials also drastically cut their outlook for economic growth in 2022, now forecasting only a 1.7% gain in GDP, down from 2.8% from March.
Projected inflation as measured by personal consumption expenditure also rose from 4.3% to 5.2% this year, although core inflation, which excludes rapidly rising food and energy, being indicated at 4.3%, up only 0.2 percentage points from the previous projection. Core PCE inflation came in at 4.9% in April, so Wednesday’s projections call for price pressures to ease in the months ahead.
The committee’s statement painted a largely bullish picture for the economy, even with higher inflation.
“Overall economic activity appears to have recovered after declining slightly in the first quarter,” the statement said. “Jobs gains have been robust in recent months and the unemployment rate has remained low. Inflation remains elevated, reflecting pandemic-related supply and demand imbalances, rising oil prices energy and broader price pressures.”
Indeed, the estimates as expressed in the committee’s summary of economic projections call for a sharp drop in inflation in 2023, to 2.6% for the headline and 2.7% for the core, with expectations having little changed from March.
Longer term, the committee’s policy outlook is largely in line with market projections that predict a series of upcoming hikes that would take the funds rate to around 3.8%, its highest level since late 2007.
The statement was endorsed by all FOMC members except Kansas City Fed President Esther George, who preferred a lower half-point increase.
Banks use the rate as a benchmark for what they charge each other for short-term borrowing. However, it directly impacts a host of consumer credit products, such as adjustable rate mortgages, credit cards, and auto loans.
The funds rate can also drive up rates on savings accounts and CDs, although the impact on this usually takes longer.
“Strongly committed” to the 2% inflation target
The Fed’s decision comes with inflation at its fastest pace in over 40 years. Central bank officials use the funds rate to try to slow the economy – in this case, to dampen demand so that supply can catch up.
However, the post-meeting statement deleted a long-used phrase that the FOMC “expects inflation to return to its 2% target and the labor market to remain strong.” The statement only noted that the Fed “is strongly committed” to the goal.
The policy tightening comes as economic growth is already slowing as prices continue to rise, a condition known as stagflation.
First-quarter growth declined to an annualized 1.5%, and an updated estimate Wednesday from the Atlanta Fed, through its tracker GDPNow, said the second quarter was flat. Two consecutive quarters of negative growth is a widely used rule of thumb to delineate a recession.
Fed officials indulged in a public outburst of hand-wringing ahead of Wednesday’s decision.
For weeks, policymakers have insisted that increases of half a point — or 50 basis points — could help bring inflation to a halt. In recent days, however, CNBC and other outlets have reported that the conditions are in place for the Fed to go beyond. The change in approach came even though Powell in May had insisted that a 75 basis point hike was not on the cards.
However, a recent series of alarming signals has triggered the most aggressive action.
Inflation as measured by the consumer price index increased by 8.6% year on year in May. The University of Michigan consumer sentiment survey hit an all-time low that included significantly higher inflation expectations. Additionally, retail sales figures released on Wednesday confirmed that the all-important consumer is weakening, with sales down 0.3% for a month in which inflation rose 1%.
The labor market was a strong point for the economy, although May’s gain of 390,000 was the lowest since April 2021. Average hourly wages rose in nominal terms, but when adjusted for the inflation, they have fallen by 3% over the past year.
The committee’s projections released on Wednesday see the unemployment rate, currently at 3.6%, rising to 4.1% by 2024.
All of these factors combined to complicate Powell’s hopes of a “soft or soft” landing that he expressed in May. Rate-tightening cycles in the past have often resulted in recessions.
Correction: Core PCE inflation stood at 4.9% in April. An earlier version incorrectly indicated the month.