U.S. Fed attacks inflation with huge hike and expects more
Officials seek `soft landing' but experts predict full-blown recession will happen
Intensifying its fight against high inflation, the Federal Reserve raised its key interest rate Wednesday by a substantial three-quarters of a point for a third straight time and signalled more large rate hikes to come — an aggressive pace that will heighten the risk of an eventual recession.
The Fed's move boosted its benchmark short-term rate, which affects many consumer and business loans, to a range of three per cent to 3.25 per cent, the highest level since early 2008.
The officials also forecast that they will further raise their benchmark rate to roughly 4.4 per cent by year's end, a full percentage point higher than they had forecast as recently as June. And they expect to raise the rate further next year, to about 4.6 per cent. That would be the highest level since 2007.
The central bank's action Wednesday followed a government report last week that showed high costs spreading more broadly through the economy. By raising borrowing rates, the Fed makes it costlier to take out a mortgage or an auto or business loan. Consumers and businesses then presumably borrow and spend less, cooling the economy and slowing inflation.
Speaking at a news conference, chairman Jerome Powell said that before Fed officials would consider halting their rate hikes, they would “want to be very confident that inflation is moving back down” to their two-per-cent inflation target. He noted that the strength of the job market is fuelling wage gains that are helping drive up inflation.
Fed officials have said they are seeking a “soft landing,” by which they would manage to slow growth enough to tame inflation but not so much as to trigger a recession. Yet most economists say they think the Fed's steep rate hikes will lead, over time, to job cuts, rising unemployment and a full-blown recession late this year or early next year.
“No one knows whether this process will lead to a recession, or if so, how significant that recession would be,” Powell said at his news conference. “That's going to depend on how quickly we bring down inflation.”
In their updated economic forecasts, the Fed's policymakers project that economic growth will remain weak for the next few years, with rising unemployment. It expects the jobless rate to reach 4.4 per cent by the end of 2023, up from its current level of 3.7 per cent. Historically, economists say, any time the unemployment rate has risen by a half-point over several months, a recession has always followed.
Fed officials now see the economy expanding just 0.2 per cent this year, sharply lower than its forecast of 1.7-per-cent growth just three months ago. And it expects sluggish growth below two per cent from 2023 through 2025.
And even with the steep rate hikes the Fed foresees, it still expects core inflation — which excludes the volatile food and gas categories — to be 3.1 per cent at the end of next year, well above its two-per-cent target.
Powell acknowledged in a speech last month that the Fed's moves will “bring some pain” to households and businesses. And he added that the central bank's commitment to bringing inflation back down to its two-per-cent target was “unconditional.”
Falling gas prices have slightly lowered headline inflation, which was a still-painful 8.3 per cent in August compared with a year earlier. Declining gas prices might have contributed to a recent rise in U.S. President Joe Biden's public approval ratings, which Democrats hope will boost their prospects in the November midterm elections.
Short-term rates at a level the Fed is now envisioning would make a recession likelier next year by sharply raising the costs of mortgages, car loans and business loans. The economy hasn't seen rates as high as the Fed is projecting since before the 2008 financial crisis. Last week, the average fixed mortgage rate topped six per cent, its highest point in 14 years. Credit card borrowing costs have reached their highest level since 1996, according to Bankrate.com.
Inflation now appears increasingly fuelled by higher wages and by consumers' steady desire to spend and less by the supply shortages that had bedevilled the economy during the pandemic recession.
On Sunday, though, Biden said on CBS'S 60 Minutes that he believed a soft landing for the economy was still possible, suggesting that his administration's recent energy and health-care legislation would lower prices for pharmaceuticals and health care.
Some economists are beginning to express concern that the Fed's rapid rate hikes — the fastest since the early 1980s — will cause more economic damage than necessary to tame inflation. Mike Konczal, an economist at the Roosevelt Institute, noted that the economy is already slowing and that wage increases — a key driver of inflation — are levelling off and by some measures even declining a bit.
Surveys also show that Americans are expecting inflation to ease significantly over the next five years. That is an important trend because inflation expectations can become self-fulfilling: If people expect inflation to ease, some will feel less pressure to accelerate their purchases. Less spending would then help moderate price increases.
Konczal said there is a case to be made for the Fed to slow its rate hikes over the next two meetings.
“Given the cooling that's coming,” he said, “you don't want to rush into this.”
The Fed's rapid hikes mirror steps that other major central banks are taking, contributing to concerns about a potential global recession. The European Central Bank last week raised its benchmark rate by three-quarters of a percentage point. The Bank of England, the Reserve Bank of Australia and the Bank of Canada have all carried out hefty hikes in recent weeks.
No one knows whether this process will lead to a recession ... That's going to depend on how quickly we bring down inflation.