US Fed announces biggest interest rate hike since 1994

The Federal Reserve announced the most aggressive interest rate increase in nearly 30 years, raising the benchmark borrowing rate by 0.75 percentage points on Wednesday as it battles against surging inflation.

The Fed’s policy-setting Federal Open Market Committee reaffirmed that it remains “strongly committed to returning inflation to its 2 per cent objective” and expects to continue to raise the key rate.

Until recently, the central bank seemed set to approve a 0.5 percentage-point increase, but economists say the rapid surge in inflation put the Fed behind the curve, meaning it needed to react strongly to prove its resolve to combat inflation

The super-sized move was the first 75-basis-point increase since November 1994.

Fed Chair Jerome Powell will hold a press conference after the meeting to provide more details on the central bank’s plans, which will be closely watched for signals on how aggressive policymakers will be in coming meetings.

Committee members now see the federal funds rate ending the year at 3.4 per cent, up from the 1.9 per cent projection in March, according to the median quarterly forecast.

They also expect the Fed’s preferred inflation index to rise to 5.2 per cent by the end of the year, with GDP growth slowing to 1.7 per cent in 2022 from the previous 2.8 per cent forecast.

The FOMC noted that effects of Russia’s invasion of Ukraine are “creating additional upward pressure on inflation and are weighing on global economic activity.”

And ongoing COVID-19 lockdowns in China “are likely to exacerbate supply chain disruptions.”

Kansas City Federal Reserve Bank President Esther George, a noted inflation-hawk, dissented from the committee vote, preferring a smaller, half-point increase.

Caught off guard

US central bankers began raising interest rates off zero in March as buoyant demand from American consumers for homes, cars and other goods clashed with transportation and supply chain snarls in parts of the world where COVID-19 remained — and remains — a challenge.

That fueled inflation, which got dramatically worse after Russia invaded Ukraine in late February and Western nations imposed steep sanctions on Moscow, sending food and fuel prices up at a blistering rate.

US gasoline prices have topped $5.00 a gallon for the first time ever and are setting new records daily.

Economists thought March was the peak for consumer price hikes, but the rate spiked again in May, jumping 8.6 per cent in the latest 12 months, and wholesale prices surged as well, almost entirely due to soaring costs for energy, especially gasoline.

The Fed was caught off guard with the speed of the price increases, and while policymakers usually prefer to clearly telegraph any policy shift to financial markets, the latest data changed the calculus.

Powell had indicated policymakers were poised to implement another half-point increase in the benchmark borrowing rate this week and a similar move next month, aiming to douse red-hot inflation without tipping the economy into recession and avoid a bout of 1970s-style stagflation.

However, the central bank cannot influence supply issues, and rate hikes only work by cooling demand and slowing the economy — meaning policymakers are walking a fine line between having an impact and doing too much.

And the impact won’t be immediate.

“Monetary policy operates with lags, today’s inflation reflects decisions taken a year ago,” said Adam Posen, head of the Peterson Institute for International Economics and a former central banker.

“Had Fed hiked in 2021Q2/Q3, then inflation now would be different — not least (because) the current global shocks wouldn’t be piling on already high inflation,”

  • The super-sized move was the first 75-basis-point increase since November 1994.
  • Central bank seemed set to approve a 0.5 percentage-point increase, but economists say rapid surge in inflation put Fed behind the curve.

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