Home » Fed hikes its benchmark interest rate by 0.75 percentage points, the biggest increase since 1994

Fed hikes its benchmark interest rate by 0.75 percentage points, the biggest increase since 1994

KEY POINTS

The Federal Reserve raised its benchmark interest rates three-quarters
of a percentage point in its most aggressive hike since 1994.
According to the “dot plot” of individual members’ expectations, the
Fed’s benchmark rate will end the year at 3.4%, an upward revision of
1.5 percentage points from the March estimate.
Officials also significantly cut their outlook for 2022 economic
growth, now anticipating just a 1.7% gain in GDP, down from 2.8% in
March.

The Federal Reserve on Wednesday launched its biggest broadside yet
against inflation, raising benchmark interest rates three-quarters of
a percentage point in a move that equates to the most aggressive hike
since 1994.

Ending weeks of speculation, the rate-setting Federal Open Market
Committee took the level of its benchmark funds rate to a range of
1.5%-1.75%, the highest since just before the Covid pandemic began in
March 2020.

Stocks were volatile after the decision but turned higher as Fed
Chairman Jerome Powell spoke in his post-meeting news conference.

“Clearly, today’s 75 basis point increase is an unusually large one,
and I do not expect moves of this size to be common,” Powell said. He
added, though, that he expects the July meeting to see an increase of
50 or 75 basis points. He said decisions will be made “meeting by
meeting” and the Fed will “continue to communicate our intentions as
clearly as we can.”

“We want to see progress. Inflation can’t go down until it flattens
out,” Powell said. “If we don’t see progress … that could cause us
to react. Soon enough, we will be seeing some progress.”

FOMC members indicated a much stronger path of rate increases ahead to
arrest inflation moving at its fastest pace going back to December
1981, according to one commonly cited measure.

The Fed’s benchmark rate will end the year at 3.4%, according to the
midpoint of the target range of individual members’ expectations. That
reflects an upward revision of 1.5 percentage points from the March
estimate. The committee then sees the rate rising to 3.8% in 2023, a
full percentage point higher than what was expected in March.

2022 growth outlook cut

Officials also significantly cut their outlook for 2022 economic
growth, now anticipating just a 1.7% gain in GDP, down from 2.8% in
March.

The inflation projection as gauged by personal consumption
expenditures also rose to 5.2% this year from 4.3%, though core
inflation, which excludes rapidly rising food and energy costs, is
indicated at 4.3%, up just 0.2 percentage points from the previous
projection. Core PCE inflation ran at 4.9% in April, so the
projections Wednesday anticipate an easing of price pressures in the
coming months.

The committee’s statement painted a largely optimistic picture of the
economy even with higher inflation.

“Overall economic activity appears to have picked up after edging down
in the first quarter,” the statement said. “Job gains have been robust
in recent months, and the unemployment rate has remained low.
Inflation remains elevated, reflecting supply and demand imbalances
related to the pandemic, higher energy prices, and broader price
pressures.”

Indeed, the estimates as expressed through the committee’s summary of
economic projections see inflation moving sharply lower in 2023, down
to 2.6% headline and 2.7% core, expectations little changed from
March.

Longer-term, the committee’s outlook for policy largely matches market
projections which see a series of increases ahead that would take the
funds rate to about 3.8%, its highest level since late 2007.

The statement was approved by all FOMC members except for Kansas City
Fed President Esther George, who preferred a smaller half-point
increase.

Banks use the rate as a benchmark for what they charge each other for
short-term borrowing. However, it feeds directly through to a
multitude of consumer debt products, such as adjustable-rate
mortgages, credit cards, and auto loans.

The fund’s rate also can drive rates on savings accounts and CDs
higher, though the feed-through on that generally takes longer.

‘Strongly committed’ to 2% inflation goal

The Fed’s move comes with inflation running at its fastest pace in
more than 40 years. Central bank officials use the fund’s rate to try
to slow down the economy – in this case, to tamp down demand so that
supply can catch up.

However, the post-meeting statement removed a long-used phrase
indicating that the FOMC “expects inflation to return to its 2 percent
objective and the labor market to remain strong.” The statement only
noted that the Fed “is strongly committed” to the goal.

The policy tightening is happening with economic growth already
tailing off while prices still rise, a condition known as stagflation.

First-quarter growth declined at a 1.5% annualized pace, and an
updated estimate Wednesday from the Atlanta Fed, through its GDPNow
tracker, put the second quarter as flat. Two consecutive quarters of
negative growth is a widely used rule of thumb to delineate a
recession.

Fed officials engaged in a public bout of hand-wringing heading into
Wednesday’s decision.

For weeks, policymakers had been insisting that half-point – or 50
basis point – increases could help arrest inflation. In recent days,
though, CNBC and other media outlets reported that conditions were
ripe for the Fed to go beyond that. The changed approach came even
though Powell in May had insisted that hiking by 75 basis points was
not being considered.

However, a recent series of alarming signals triggered the more
aggressive action.

Inflation as measured by the consumer price index rose 8.6% on a
yearly basis in May. The University of Michigan consumer sentiment
survey hit an all-time low that included sharply higher inflation
expectations. Also, retail sales numbers released Wednesday confirmed
that the all-important consumer is weakening, with sales dropping 0.3%
for a month in which inflation rose 1%.

The jobs market has been a point of strength for the economy, though
May’s 390,000 gain was the lowest since April 2021. Average hourly
earnings have been rising in nominal terms, but when adjusted for
inflation have fallen 3% over the past year.

The committee projections released Wednesday to see the unemployment
rate, currently at 3.6%, moving up to 4.1% by 2024.

All of those factors have combined to complicate Powell’s hopes for a
“soft or softish” landing that he expressed in May. Rate-tightening
cycles in the past often have resulted in recessions.

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