The Federal Reserve raised its benchmark policy rate by 0.75 percent points for the first time in three decades and signaled an aggressive pace of monetary tightening in the coming months as it stepped up efforts to tame the highest US inflation in 40 years.
At the end of its two-day policy meeting, the Federal Open Market Committee on Wednesday lifted its benchmark policy rate to a new target range of 1.50 per cent to 1.75 per cent, noting in a statement that it “anticipates that ongoing increases in the target range will be appropriate ”.
The decision marks an abrupt pivot from the Fed’s previously telegraphed plans for a second consecutive 0.50 percent point rate rise, which had been explicitly signalled by policymakers before the start of a scheduled “blackout” period ahead of the meeting during which their public communications are limited .
Esther George, president of the central bank’s Kansas City branch, was the sole dissenter, and instead backed adhering to the Fed’s previous guidance.
The increase comes after two alarming reports released on Friday showed an unexpectedly large jump in consumer prices in May and a worrying rise in inflation expectations, suggesting that Americans are growing more concerned about the economic outlook.
“The committee is highly attentive to inflation risks,” the Fed said in its statement, flagging that Russia’s invasion of Ukraine has created “additional upward pressure” on inflation and weighing on economic activity. It also added that extended lockdowns in China to combat Covid-19 surges are further worsening supply chain disruptions that have helped to bid up prices.
Officials at the US central bank also on Wednesday sharply raised their rate forecasts compared to three months ago, when they had pencilled in the federal funds rate reaching 1.9 per cent by year end and 2.8 per cent in 2023.
The “dot plot” of individual interest rate projections now suggests the policy rate will rise to 3.4 per cent by the end of 2022 – a level that suggests the Fed could implement at least one more 0.75 percent point increase this year and a couple half- point adjustments before moderating to a more typical quarter-point cadence.
Additional interest rate increases are also anticipated in 2023, with officials indicating the policy rate could reach 3.8 per cent. Notably, the median forecast for the federal funds rate in 2024 was 3.4 per cent, suggesting the Fed will need to reverse its ongoing rate rises in recognition of the fact that the economy is likely to have slowed considerably by that point.
Alongside the dot plot, the Fed published new economic projections that more directly indicate that the forthcoming monetary tightening – which also includes a scaling-back of the $ 9tn balance sheet – will involve “some pain”, as Jay Powell, the Fed chair, acknowledged last month.
Annual growth in gross domestic product is now forecast to slow to 1.7 per cent by the end of this year and maintain that level in 2023, according to the median of top officials’ economic estimates. In March, they had predicted the economy would expand each year by 2 per cent or more through 2024.
Fed officials now expect core inflation to settle at 4.3 per cent this year and 2.7 per cent in 2023, slightly higher than what was forecast in March. Reflecting the impact of tightening policy, the unemployment rate is forecast to rise more substantially than the 3.5 per cent level officials in March had pencilled in through the end of next year. It is now set to reach 3.9 per cent in 2023 and 4.1 per cent in 2024. It currently stands at 3.6 per cent.
The Fed is not alone in its efforts to tackle inflation, which has become a global phenomenon. Central banks across advanced and emerging economies have been rapidly raising interest rates in short order, with plans to do more this year.
The European Central Bank has since been forced to fine tune its policy, however. It convened an emergency meeting of its rate-setters on Wednesday where it announced new emergency measures to tackle surging borrowing costs in weaker eurozone economies.
US financial markets lost ground rapidly after the statement was released, with the benchmark S&P 500 reversing most of its gains from earlier in the trading day. The stock market gauge was up 0.4 per cent in the minutes after the release.
The $ 23tn US Treasury market was also mixed as traders digested the decision. The yield on the 10-year note – which sets borrowing costs across the globe – was 0.04 percent points lower for the day at 3.43 per cent, up from a low of 3.35 per cent earlier in the session. Yields rise when bond prices fall.
There were other signs that investors took new forecasts from the US central bank to reinforce their views that economic growth was faltering. The yield curve briefly inverted on Wednesday, a signal some investors look to for a forthcoming recession.