Fed conducts historic interest rate hike in desperate bid to control inflation

Following a two-day meeting, the Federal Open Market Committee announced Wednesday that it would increase its interest rate target by three-quarters of a percentage point, to a range of 1.5% to 1.75%. The central bank typically raises rates by just a quarter of a percentage point, so the move signals that the Fed is now scrambling to drive down prices.

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“The Committee is strongly committed to returning inflation to its 2% objective,” Fed officials said in a statement, a more forceful declaration than is typical.

The drastic move comes just days after May’s consumer price index report came in hotter than expected and showed prices increased by 8.6% on an annual basis, the fastest clip since 1981 during the Great Inflation that helped sweep President Ronald Reagan into office.

“Indicators of inflation expectations have risen, and projections for inflation have been revised up notably. In response to these developments, the committee decided that a larger increase in the target range was warranted at today’s meeting,” Fed Chairman Jerome Powell told reporters at a news conference on Wednesday.

Prior to Friday’s report, it was nearly unanimously believed that the central bank would conduct a half-percentage-point hike, as it did at its May meeting, but the report clearly caused Federal Open Market Committee members to reconsider how aggressive they need to be to tame the inflationary plague.

The aggressive tack taken by the Fed is the first rate increase of its size since 1994.

The high rate of inflation has damaged President Joe Biden politically. Republicans have blamed Democrats for stoking inflation by spending so much in Biden’s first year in office.

Central bank officials also indicated in projections released Wednesday that they expect to increase the degree of rate hikes in the coming months in response to the hotter-than-anticipated inflation. The Fed’s benchmark rate will end this year at 3.4%, the projections suggest, a much faster pace of tightening than previously expected.

All parts of the economy are facing price pressures, but energy prices and food prices, in particular, have exploded over the past several months, hurting consumers by making staples such as gas and groceries increasingly less affordable.

The officials also raised their projections for inflation. The median Fed official now sees inflation at 5.2% by the end of the year, compared to a March projection of 4.3%. Inflation projections remained about the same for both 2023 and 2024.

The Fed also upped its forecast for the unemployment rate in the coming months and years. It now predicts the unemployment rate will tick up to 3.7% by the end of the year and 4.1% by 2024, a sign that the central bank may be acknowledging the effect its aggressive tightening will have on the economy.

The FOMC members also slashed the GDP growth forecast for this year from the March projection of 2.8% down to 1.7%, and officials also revised down their GDP predictions for next year and 2024.

The Fed’s action on Wednesday comes after consumer sentiment sunk to record levels, according to a report released on Friday.

The University of Michigan Consumer Sentiment Index plunged to 50.2 in June, down from 58.4 in May and by more than 40% on the year.

Still, monetary tightening has a far greater influence on the demand side of the equation but does little to combat inflation caused by the supply side. War in Ukraine is roiling energy supplies, and supply chain problems are still ongoing, exacerbated by China’s strict coronavirus lockdown policies.

While raising rates depresses demand and should cause the rate of inflation to decrease, it also slows spending. Many economists fear that the Fed’s more aggressive course of action will knock the economy into a recession.

The S&P 500 fell into a bear market on Monday to start the week, an indication that investors are fearful about the economy’s future as interest rates rise. A bear market is a term used to describe an index dropping by at least 20% from a recent high.

A survey, conducted by the Financial Times in partnership with the University of Chicago’s Booth School of Business and released on Monday, found that 68% of the leading academic economists surveyed believe the most likely timing of a recession will be sometime next year.

Some leading voices in the finance world are also ringing the alarm bells about a recession. JPMorgan Chase CEO Jamie Dimon recently told investors to be prepared for an economic “hurricane.”

Dimon said the Federal Reserve’s plan to continue hiking interest rates, combined with uncertainty surrounding the war in Ukraine, is causing his firm to batten down the hatches.

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While the Fed is hoping to knock down inflation quickly, it will still take months for prices to settle back down to the central bank’s 2% target, meaning that consumers will continue to feel the sting as they head to voting booths for the midterm elections in November.
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