The Federal Reserve raised its key short-term interest rate by a half percentage point Wednesday, its largest hike since 2000, and signaled further big moves may lie ahead as officials scramble to curtail a historic spike in inflation.
In a statement after a two-day meeting, Fed policymakers reiterated that “ongoing increases” in the federal funds rate “will be appropriate.”
Top economists expect the Fed to lift the rate to a range of 2.25% to 2.5% by the end of the year.
Analysts will be scrutinizing Fed Chair Jerome Powell’s remarks at a 2:30 p.m. media conference on Wednesday for any hints of a more rapid rate rise, including the possibility of a three-quarters point hike at a meeting.
The central bank also said it will begin shrinking its $9 trillion in bond holdings next month, a strategy that will nudge long-term interest rates higher.
Wednesday’s hike, which was widely expected, boosts the Fed’s benchmark rate from a range of 0.25% to 0.5% to a range of 0.75% to 1%.
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It’s expected to set off a domino effect through the economy, pushing up rates for credit cards, home equity lines of credit and adjustable-rate mortgages, among other loans. At the same time, Americans, particularly seniors, should start to benefit from higher bank savings rates after years of negligible returns.
In a statement after a two-day meeting, the Fed acknowledged the economy contracted early in the year but said it’s still fundamentally strong.
“Although overall economic activity edged down in the first quarter, household
spending and business fixed investment remained strong,” the Fed said. “Job gains have been robust in recent months, and the unemployment rate has declined substantially.”
And the Fedit underscored its vigilance about rising prices.
Besides Russia’s war in Ukraine, the Fed noted that “COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is highly attentive to inflation risks.”
The Fed hikes rates to curb borrowing, cool off an overheated economy and fend off inflation spikes. It lowers them to spur borrowing, economic activity and job growth.
Early in the pandemic, amid unprecedented business closures and layoffs, the Fed slashed its federal funds rate to zero and launched massive bond purchases to lower long-term rates.
Now, however, the Fed is combatting sky-high inflation even as growth is slowing from last year’s robust 5.7% pace. That marked a 37-year high as vaccinations increased and the economy reopened.
The unusual dynamic is stoking worries that rapid Fed rate hikes could tip the economy into recession.
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Before the meeting, Goldman and Barclays predicted the Fed would raise rates by half a percentage point both Wednesday and at a mid-June meeting before pulling back to quarter-point hikes the rest of the year. That would take the federal funds rate to the 2.25% to 2.5% range considered “neutral” by the end of the year because it theoretically would neither juice nor dampen economic growth.
Did the Fed take inflation too lightly?
The Fed has consistently underestimated inflation’s staying power, forcing policymakers to repeatedly ramp up their rate hike plans. As recently as early November, Fed officials were calling inflation a “transitory” byproduct of an economy recovering from the COVID-19-induced recession and related supply chain bottlenecks.
By December, they acknowledged price increases were more persistent than they thought and forecast three rate increases in 2022, up from one in their September outlook. That would bring the rate to about 0.9% by year’s end.
In March, with inflation heating up further amid the Russia-Ukraine war, the Fed lifted its key rate – by a quarter-point from near zero – for the first time in more than three years. It also revised upward its year-end rate estimate to 1.9%.
Now, the Fed is revamping its playbook again, with economists predicting a federal funds rate of about 2.4% by December and warning a higher rate is possible.
Behind the aggressive approach is annual inflation that reached a new 40-year high of 8.6% in March. Economists blame the supply snarls, pandemic-related worker shortages that have boosted wages and strong consumer demand heightened by federal stimulus money.
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Total employee compensation surged by a 32-year high of 1.4% in the first quarter, the Labor Department said, intensifying fears of a wage-price spiral that could be difficult to tame.
And hiring has been stronger than anticipated. Employers added an average of 562,000 jobs a month from January to March as more than two million Americans streamed back into a favorable labor market with record job openings.
That has stirred fears of further wage and price increases and bolstered the Fed’s belief that the economy is healthy enough to withstand large rate hikes.
Has inflation peaked?
The government said last week the economy unexpectedly contracted by 1.4% in the first quarter. But the poor showing was traced to weaker inventory building and a widening trade deficit, both of which are volatile. Consumer and business spending – the core of the economy — notched solid gains.
At the same time, many economists believe inflation has peaked, with supply snags starting to ease and a growing labor force easing wage pressures. That could lessen the need for the Fed to continue to lift rates dramatically later this year.
The central bank on Wednesday also said it will begin shedding the trillions of dollars in Treasury bonds and mortgage-backed securities it has amassed. The purchases ballooned the Fed’s balance sheet to about $9 trillion.
Rather than sell the bonds outright, which could disrupt markets, the Fed plans to gradually trim its holdings by not reinvesting the proceeds from some of the assets as they mature.
The Fed said it would reduce the Treasury bonds in June by up to $30 billion and the mortgage securities by up to $17.5 billion, ramping up those levels to $60 billion and $35 billion, respectively, within three months. Fed officials also have discussed the possibility of selling the assets to diminish its balance sheet more quickly if necessary.
The shrinking holdings should nudge mortgage and other long-term rates higher over the next few .