The Federal Reserve on Wednesday enacted its second consecutive 0.75 percentage point increase in interest rates as it seeks to curb inflation without creating a recession.
By bringing the benchmark one-day rate to a range of 2.25% to 2.5%, the moves in June and July represent the tightest consecutive moves since the Fed began using the overnight funds rate as the main monetary policy tool in the early nineties. .
While the fed funds rate most directly affects what banks charge each other for short-term loans, it feeds into a host of consumer products, including adjustable-rate mortgages, auto loans and credit cards. The increase takes the funds rate to its highest level since December 2018.
Markets had largely expected the move after Fed officials telegraphed the hike in a series of statements since the June meeting and held on to gains after the announcement. Central banks have emphasized the importance of reducing inflation even if this means slowing the economy.
In its statement after the meeting, the Federal Open Market Committee on rate-setting warned that “recent indicators of spending and production have softened.”
“Nevertheless, job gains have been robust in recent months and the unemployment rate has remained low,” the committee added, using similar language to the June statement. Officials again described inflation as “elevated” and attributed the situation to supply chain issues and higher food and energy prices along with “broader price pressures”.
The rate increase was approved unanimously. In June, Kansas City Fed President Esther George disagreed, arguing for a slower course with a half-percentage-point hike.
The increases come in a year that began with rates hovering around zero, but has seen a commonly cited measure of inflation sit at 9.1% a year. The Fed targets inflation around 2%, although it adjusted that target in 2020 to allow it to run a bit more in the interest of full and inclusive employment.
In June, the unemployment rate remained at 3.6%, close to full employment. But inflation, even by the Fed’s core personal consumption expenditure standard, which stood at 4.7% in May, is well off target.
Efforts to reduce inflation are not without risks. The US economy is teetering on the brink of recession as inflation slows consumer purchases and affects business activity.
First-quarter GDP declined by an annualized 1.6 percent, and markets were bracing for a second-quarter reading due on Thursday that could show consecutive declines, a widely used barometer for a recession. The Dow Jones estimate for Thursday’s reading is for growth of 0.3%.
Along with the rate hikes, the Fed is shrinking the size of the asset holdings on its nearly $9 trillion balance sheet. Starting in June, the Fed began allowing some of the proceeds from maturing bonds to be withdrawn.
The balance sheet has shrunk by just $16 billion since the start of the downturn, though the Fed set a cap of up to $47.5 billion that could have been liquidated. The cap will rise over the summer and reach $95 billion a month in September. The process is known in the markets as “quantitative tightening” and is another mechanism the Fed uses to affect financial conditions.
Along with the accelerated balance sheet runoff, markets expect the Fed to raise rates by at least half a percentage point in September. Traders on Wednesday afternoon were assigning about a 53% chance the central bank would go even further, with a third straight hike of 0.75 percentage points, or 75 basis points, in September, according to Group data CME.
The FOMC does not meet in August, but officials will gather in Jackson Hole, Wyoming, for the Fed’s annual retreat.
Markets expect the Fed to start cutting rates next summer, although the committee’s projections released in June do not show cuts until at least 2024.
Several officials have said they expect to hike aggressively until September and then assess what impact the moves had on inflation. Despite increases totaling 1.5 percentage points between March and June, June’s consumer price index reading was the highest since November 1981, with the rent index at its highest level since April 1986 and dental care costs hit a record in a data series going back. until 1995.
The central bank has faced criticism, both for being too slow to tighten when inflation began to accelerate in 2021, and for possibly going too far and triggering a more severe economic downturn.
Sen. Elizabeth Warren (D-Mass.) told CNBC on Wednesday that she was concerned that the Fed’s hikes would pose an economic danger to those at the lower end of the economic spectrum by raising unemployment .