WASHINGTON – The United States Federal Reserve (Fed) had approved its highest interest rate increase on June 15, marking it as the largest hike in 25 years to curb inflation.
Reuters reported that the US central bank officials recognised that the action may erode the public’s trust in their authority. However, they felt that they are being driven by events that are increasingly viewed as being beyond their control.
The move by the Fed has been widely anticipated and saw an increase by 0.75% to a range of between 1.5% and 1.75%. The hike is reported to be still comparatively low in historic standards.
However, the Fed hardline commitment to managing inflation has already resulted in a widespread tightening of credit conditions, which is already being felt in the U.S. housing and stock markets and is likely to dampen demand across the economy. This is what the Fed had intended.
The central bank’s officials also foresee steady rate increases throughout 2022, possibly including another 75 basis points hike, and federal funds rate to reach 3.4% by the end of this year.
That would be the highest level seen since January of 2008 with the Fed projection showing that it would be enough to dampen the economy in coming months as well as lead to an increase of unemployment.
At a news conference following the end of the Fed’s latest two-day policy meeting, Fed Chair Jerome Powell stated “We don’t seek to put people out of work,” while adding that the central bank was “not trying to induce a recession.”
Nonetheless, his remarks were among his most sobering to date regarding the difficulty he and his fellow policymakers faced in trying to lower inflation from its current 40-year peak, to a level nearer to its targeted 2%, all without a sharp downturn of economic growth or a rapid increase in unemployment.
“Out goal really is to reduce inflation down to 2% while the labour market remains strong… What’s becoming increasingly clear is that many factors we are unable to control are going to play a huge role in deciding whether this is possible or not,” he stated, noting the war in Ukraine and global supply issues.
Powell said that there is a path to reach there although it is not getting easier.
He further told the reporters that the previous rate hike announced in May and March had so far not only failed to reduce inflation, but it allowed for inflation to continue accelerating to a level that recent data suggests has begun to sway public attitudes in a manner that would make the Fed’s job even more difficult.
Inflation expectations soar
A recent survey indicated that consumer inflation expectations rose sharply in June. The results were deemed “quite eye-catching” by Powell and it was enough to sway the Fed towards a larger 75 basis points increase in hopes of making quicker progress on the inflation front while preserving public confidence that price increase will moderate.
The change in consumer inflation expectations is what Powell said “is something we need to take seriously.” The action is something that policymakers are “absolutely determined to keep anchored.”
The quicker rate hike pace that were outlined by the Fed more closely aligns monetary policy with the abrupt shift in financial market sentiments over the third week of June and of what it will take to rein inflationary pressures in.
Bond yields declined following the release of the Fed projections on the same day, the forecast which showed economic growth dampening to a below-trend rate of 1.7% and that policymakers are expected to further slash interest rates in 2024. Stocks on Wall Street had ended higher on June 15 as well.
Future markets for interest rates also suggested an 85% likelihood that the Fed will increase rates by 75 basis points in their next policy meeting, slated for July. As for September’s meeting, the likelihood is higher of a 50 basis points hike.
Powell made no promises on June 15, departing from the more definitive guidance he had previously given about future rate increases.
He said that the recent inflation report had an unexpected jump and given that, a hike of 75 basis points seemed like the appropriate thing to do during this meeting.
However, he added that rate increases of this size were unlikely to “be common,” and that when the Fed regather in July, an increase of either 50 basis points or 75 basis points would be “most likely.”
Economic outlook downgraded
The move to tighten monetary policy was followed by a downgrade of the Fed’s economic outlook. The US economy is projected to slow to a below-trend 1.7% growth in 2022 while the rate of unemployment is expected to increase to 3.7% and further growing until the rate of 4.1% all through 2024.
Although none of the policymakers in the central bank had predicted an outright recession, the projected range of economic growth edged close to zero for 2023, with an index of the Fed’s opinion indicating that the officials almost unanimously believe the risks for slower growth, higher inflation and unemployment rates, are greater than anticipated.
Analysts stated that the new outlook was more realistic. Many of them had previously criticised the Fed’s March projections which saw inflation declining and modest rate hikes and no increase to the unemployment rate.
Senior investment strategist at Allspring Global Investments, Brain Jacobsen, said that the Fed is wiling to allow the unemployment rate to grow and risk a recession as collateral damage in order to reduce inflation.
“This isn’t a Volcker moment for Powell given the magnitude for the rate hike, but he is like a mini version of Volcker with this move,” he stated, referring to former Fed chair Paul Volcker whose fight against inflation in the early 80s involving sharp and unexpected rate increases that were up as much as 4% at a time.
In spite of the aggressive interest rate hikes announced on June 15, policymakers still anticipate inflation as measured by the personal consumption expenditures price index at 5.2% for 2022 to only decline gradually to 2.2% in 2024.
The issue of inflation has become the Fed’s most pressing economic issue and has begun to alter the political landscape as well, with household opinion deteriorating amidst rising food costs and oil prices.
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