WASHINGTON (AP) – Stepping up its fight against high inflation, the Federal Reserve raised its key interest rate Wednesday by a significant three-quarters of a point for the third straight time and signaled more big rate hikes to come – an aggressive pace that will increase the risk of a possible recession.
The Fed’s move raised its key short-term rate, which affects many consumer and business loans, to a range of 3% to 3.25%, the highest level since early 2008.
Officials also predicted they would raise their key interest rate further to around 4.4% by the end of the year, a full point higher than they had envisioned as recently as June. And they expect to raise the rate again next year, to around 4.6%. That would be the highest level since 2007.
By raising lending rates, the Fed makes it more expensive to get a mortgage or car or business loan. Consumers and businesses probably borrow and spend less, cooling the economy and slowing inflation.
Falling gas prices slightly dampened headline inflation, which was still a painful 8.3% in August from a year earlier. Falling gas prices may have contributed to a recent surge in President Joe Biden’s public approval rating, which Democrats hope will boost their prospects in November’s midterm elections.
Speaking at a news conference, Chairman Jerome Powell said that before Fed officials consider stopping their rate hikes, they “would like to be very confident that inflation is coming back down” to their 2 percent target. He noted that the strength of the labor market is fueling wage gains that are contributing to higher inflation.
And he emphasized his belief that containing inflation is necessary to ensure the long-term health of the labor market.
“If we want to pave the way for another period of a very strong labor market,” Powell said, “we’ve got to put inflation behind us. I wish there was a painless way to do this. There is no.”
Fed officials said they were aiming for a “soft landing,” through which they would be able to slow growth enough to tame inflation but not so much as to trigger a recession. But most economists say they believe the Fed’s sharp rate hikes will, over time, lead 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 will depend on how quickly we reduce inflation.”
In their updated economic forecasts, Fed policymakers forecast that economic growth will remain weak for years to come, with unemployment rising. It expects the unemployment rate to reach 4.4% by the end of 2023, from the current level of 3.7%. Historically, economists say, whenever the unemployment rate has risen by half a point over several months, a recession has always followed.
Fed officials now forecast the economy will grow just 0.2% this year, well below their forecast of 1.7% growth just three months ago. And they envision sluggish growth below 2% from 2023 to 2025.
And even with the sharp rate hikes the Fed forecasts, it still expects core inflation — which excludes volatile food and gas categories — to be 3.1 percent at the end of next year, well above its target 2%.
Powell acknowledged in a speech last month that the Fed’s moves would “cause some pain” to households and businesses. He added that the central bank’s commitment to reduce inflation to its 2% target was “unconditional”.
Short-term interest rates at the level the Fed now envisions will make a recession more likely next year by sharply raising the cost of mortgages, auto loans and business loans. The economy hasn’t seen interest rates as high as the Fed predicted before the financial crisis of 2008. Last week, the average fixed mortgage rate topped 6%, the highest point in 14 years. Credit card borrowing costs have reached their highest level since 1996, according to Bankrate.com.
Inflation now appears to be increasingly fueled by higher wages and a steady consumer desire to spend and less of the supply shortages that plagued the economy during the pandemic recession. On Sunday, however, Biden told CBS’ “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 drug prices products and healthcare.
The law may help lower prescription drug prices, but outside analyzes suggest it won’t directly help reduce overall inflation. Last month, the nonpartisan Congressional Budget Office found that it would have a “negligible” effect on prices through 2023. The University of Pennsylvania’s Penn Wharton Budget Model went even further, saying that “the impact on inflation is statistically indistinguishable from zero » the next decade.
But some economists are beginning to worry that the Fed’s rapid rate hikes — the fastest since the early 1980s — will do more economic damage than is needed 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 leveling off and by some measures even declining slightly.
Surveys also show that Americans expect inflation to fall significantly over the next five years. This is an important trend because inflation expectations can become self-fulfilling: If people expect inflation to fall, some will feel less pressure to accelerate their purchases. Less spending would help contain price increases.
The Fed’s rapid rate hikes mirror moves by other major central banks, adding to concerns about a potential global recession. The European Central Bank last week raised its benchmark interest rate by three-quarters of a percentage point. The Bank of England, the Reserve Bank of Australia and the Bank of Canada have all made sharp interest rate hikes in recent weeks.
And in China, the world’s second-largest economy, growth is already suffering from the government’s repeated COVID lockdowns. If recession sweeps most major economies, it could derail the US economy as well.
Even with the accelerating pace of Fed rate hikes, some economists — and some Fed officials — argue that they have yet to raise rates to a level that would actually curb borrowing and spending and slow growth.
Many economists sound convinced that widespread layoffs will be necessary to slow the rise in prices. Research published earlier this month by the Brookings Institution concluded that unemployment may need to reach as high as 7.5% for inflation to return to the Fed’s 2% target.
