WASHINGTON — The Federal Reserve on Wednesday stepped up its efforts to rein in high inflation by raising its key interest rate by three-quarters of a point — its biggest hike in nearly three decades — and signaling larger rate increases to come that would increase the risk of another recession.
The decision announced by the Fed after its last policy meeting will increase its benchmark short-term rate, which affects many personal and business loans, to a range of 1.5% to 1.75%.
The central bank is stepping up efforts to tighten credit and slow growth as inflation hit a four-decade high of 8.6%, spreading to more parts of the economy and showing no signs of slowing. Americans are also starting to expect high inflation to last longer than before. This sentiment could embed an inflationary psychology in the economy that would make it more difficult for inflation to return to the Fed’s 2% target.
The Fed’s three-quarter-point rate hike tops the half-point hike that Chairman Jerome Powell said is expected to be announced this week. The Fed’s decision to impose a rate hike as large as it did on Wednesday was an acknowledgment that it is struggling to curb the pace and persistence of inflation, which has been aggravated by the war. of Russia against Ukraine and its effects on energy prices.
Borrowing costs have already risen sharply across much of the US economy in response to Fed decisions, with the average 30-year fixed mortgage rate topping 6%, its highest level since before the 2008 financial crisis, against only 3% at the beginning. of the year. The yield on the 2-year Treasury note, a benchmark for corporate borrowing, jumped to 3.3%, its highest level since 2007.
Even if a recession can be avoided, economists say it’s almost inevitable that the Fed will have to inflict some pain — most likely in the form of higher unemployment — as the price for beating chronically high inflation.
Inflation rose to the top of voters’ concerns in the months leading up to the midterm congressional elections, degrading public opinion on the economy, weakening President Joe Biden’s approval ratings and increasing the likelihood of Democratic losses in November. Biden has sought to show he recognizes the pain inflation is causing American households, but has struggled to find policy actions that could make a real difference. The president underscored his belief that the power to rein in inflation lies primarily with the Fed.
Yet the Fed’s rate hikes are blunt tools in an attempt to reduce inflation while supporting growth. Shortages of oil, gasoline and food propel inflation. The Fed is not ideal for tackling many of the causes of inflation, which involve Russia’s invasion of Ukraine, still congested global supply chains, labor shortages work and a growing demand for services, from airline tickets to restaurant meals.
Expectations of bigger Fed hikes sent a range of interest rates to their highest levels in years. The yield on the 2-year Treasury note, the benchmark for corporate bonds, reached 3.3%, its highest level since 2007. The 10-year Treasury yield, which directly affects mortgage rates, reached 3, 4%, up almost half a point since last week and the highest level since 2011.
Investments around the world, from bonds to bitcoin, have fallen in recent months on fears surrounding high inflation and the prospect that the Fed’s aggressive drive to control it will cause a recession. Even if the Fed pulls off the trick of reining in inflation without triggering a recession, rising rates will still put pressure on stock prices. The S&P 500 has already fallen more than 20% this year, meeting the definition of a bear market.
Other central banks around the world are also moving quickly to try to contain soaring inflation, even though their countries are at greater risk of recession than the United States. The European Central Bank is expected to raise rates by a quarter point in July, its first increase in 11 years. It could announce a bigger rise in September if record inflation levels persist. On Wednesday, the ECB pledged to create a market safety net that could protect member countries against financial turmoil of the kind that erupted in a debt crisis more than a decade ago.
The Bank of England has hiked rates four times since December to a 13-year high, despite forecasts that economic growth will remain flat in the second quarter. The BOE will hold an interest rate meeting on Thursday.
The 19 European Union countries that use the euro suffered record inflation of 8.1% last month. The UK hit a 40-year high of 9% in April. Although debt servicing costs remain contained for now, rising borrowing costs for indebted governments threatened the eurozone with a breakout early in the last decade.
Last week, the World Bank warned of the threat of “stagflation” – slow growth accompanied by high inflation – in the world.
One of the main reasons a recession is now more likely is that economists increasingly believe that for the Fed to slow inflation to its 2% target, it will have to cut consumer spending sharply, earnings wages and economic growth. Ultimately, the jobless rate will almost certainly have to rise — something the Fed has yet to forecast, but may do in updated economic projections it will release on Wednesday.
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