WASHINGTON – The Federal Reserve on Wednesday launched a high-risk effort to contain the worst inflation of the early 1980s, raising its benchmark short-term interest rates and signaling six additional rate hikes this year.
The Fed’s quarterly-point increase in key rates, which pinned it close to zero since the epidemic recession two years ago, triggered its efforts to control high inflation after recovering from the recession. Rate increases mean higher debt rates for many consumers and businesses.
Under Chair Jerome Powell, the Fed expects the rate hike to serve a tougher and narrower purpose: raising borrowing costs enough to slow growth and control high inflation, yet not so much as to push the economy into recession.
Speaking at a news conference, Powell emphasized his confidence that the economy was strong enough to withstand high interest rates. But he also made it clear that the Fed is focusing on doing what it needs to do to reduce inflation over time with its 2% annual target. Otherwise, Powell warned, the economy could not recover from the epidemic recession.
“We are acutely aware of the need to restore price stability,” the Fed chair said. “In fact, it is a prerequisite for achieving the kind of labor market we want. Without price stability you will not be able to get maximum employment for a permanent period.”
The Fed also released a set of quarterly economic forecasts on Wednesday, highlighting the possibility of rising interest rates in the coming months. The seven possible rates are expected to grow at a short-term rate of between 1.75% and 2% by the end of 2022.
This will be the highest level since March 2008. Borrowing costs for mortgages, credit cards and auto loans are likely to increase.
“Clearly, inflation has shifted to the front and center,” said Tim Dui, chief US economist at SGH Macro Advisors.
According to quarterly estimates released on Wednesday, central bank policymakers expect inflation to rise to 4.3% by 2022. Officials also now forecast much slower economic growth this year, 2.8%, lower than the 4% estimate in December.
But many economists worry that inflation is already so high – it reached 7.9% in February, the worst in four decades – and as Russia’s invasion of Ukraine pushed up gas prices, the Fed may now have to raise rates more than expected and potentially cause a recession.
In its own acknowledgment, the central bank underestimated the breadth and perseverance of high inflation after the epidemic hit. And many economists say waiting too long for the Fed to start raising rates has put its work at risk.
At his press conference, Powell said he believes inflation will ease later this year as supply chain barriers clear up and more Americans return to the job market, easing upward pressure on wages.
He further suggested that over time, the Fed’s higher rates would reduce consumer spending on interest-sensitive items such as autos and cars. If credit card rates rise, Americans may buy less. These trends will ultimately reduce business demand for workers, slowing wage growth, running at a strong 6% annual rate, and easing inflationary pressures. Powell noted that there are almost a record number of job opportunities, with an average of 1.7 jobs available for each unemployed person.
As a result, he is confident that the economy will remain strong enough to sustain a steady Fed rate hike without creating a recession.
“All indications are that this is a strong economy,” he said.
The Fed’s forecast for a number of additional rate hikes in the coming months initially hampered a strong rally on Wall Street, weakening stock gains and boosting bond yields. But after Powell began his press conference, stock prices recovered more than their gains and suggested that the Fed would remain flexible in the process of raising rates.
Most economists say that the sharply high rates of arrears are long overdue for the economy to cope with rising inflation.
“Unemployment rates below 4%, inflation close to 8%, and the war in Ukraine could put even more upward pressure on prices, which is what the Fed needs to do to bring inflation under control,” said Mike Fratantoni, chief economist at Mortgage Bankers Assoc.
In a statement issued after its latest policy meeting, the Fed noted that Russia’s invasion of Ukraine and Western sanctions could “create additional upward pressure on inflation and affect economic activity.”
Powell is taking the Fed on a sharp U-turn. Officials kept rates very low to support growth and recruitment during the recession and its aftermath. As recently as December, Fed officials expected the rate to rise only three times this year.
James Bullard, a member of the Fed’s rate-setting committee, the head of the Federal Reserve Bank of St. Louis, disagreed with Wednesday’s decision. Bullard favors a half-point rate hike, a position he has endorsed in interviews and speeches.
The Fed also said it would begin reducing its nearly $ 9 trillion balance sheet, which had more than doubled in size during the epidemic, “at an upcoming meeting.” That move would also have the effect of tightening credit for many consumers and businesses.
Since its last meeting in January, challenges and uncertainties have grown for the Fed. Russia’s aggression has pushed up prices of oil, gas, wheat and other commodities. China has again shut down ports and factories in an attempt to contain a new outbreak of covid, which will disrupt the supply chain and possibly increase further fuel price pressures.
Meanwhile, a sharp rise in average gas prices since the attack, more than 60 cents nationally at $ 4.31 per gallon, will send inflation higher and possibly lower growth – two conflicting trends that the Fed is notoriously difficult to handle simultaneously.
Contrary to some analysts, Glenmede’s chief investment officer Jason Pride said he thinks Russia’s attack could lead the Fed to a relatively slow approach.
“The war in Eastern Europe is unlikely to stop the Fed’s tough plan, but it could be cautious about the pace of rate hikes because the economic implications of the conflict are better understood,” Pride said.
Paul Wisman, author of AP Economics, contributed to this report.