Fed hikes interest rates by 0.75 percentage points for the second consecutive time to fight inflation

KEY POINTS

The Federal Reserve on Wednesday enacted its second consecutive 0.75
percentage point interest rate increase, taking its benchmark rate to
a range of 2.25%-2.5%.
Chair Jerome Powell said there will be a point where the Fed starts to
slow hikes to assess their impact.
“We actually think we need a period of growth below potential in order
to create some slack,” he said.

The Federal Reserve on Wednesday enacted its second consecutive 0.75
percentage point interest rate increase as it seeks to tamp down
runaway inflation without creating a recession.

In taking the benchmark overnight borrowing rate up to a range of
2.25%-2.5%, the moves in June and July represent the most stringent
consecutive action since the Fed began using the overnight funds’ rate
as the principal tool of monetary policy in the early 1990s.

While the fed funds rate most directly impacts what banks charge each
other for short-term loans, it feeds into a multitude of consumer
products such as adjustable mortgages, auto loans, and credit cards.
The increase takes the funds rate to its highest level since December
2018.


Markets largely expected the move after Fed officials telegraphed the
increase in a series of statements since the June meeting. Stocks hit
their highs after Fed Chair Jerome Powell left the door open about its
next move at the September meeting, saying it would depend on the
data. Central bankers have emphasized the importance of bringing down
inflation even if it means slowing the economy.

“As the stance of monetary policy tightens further, it likely will
become appropriate to slow the pace of increases while we assess how
our cumulative policy adjustments are affecting the economy and
inflation,” Powell said.


In its post-meeting statement, the rate-setting Federal Open Market
Committee cautioned that “recent indicators of spending and production
have softened.”

“Nonetheless, job gains have been robust in recent months, and the
unemployment rate has remained low,” the committee added, using
language similar to the June statement. Officials again described
inflation as “elevated” and ascribed the situation to supply chain
issues and higher prices for food and energy along with “broader price
pressures.”

Powell said he does not think the economy is in recession, though
growth was negative in the first quarter and was expected to be barely
positive in the second quarter.


“Think about what a recession is. It’s a broad-based decline across
many industries that are sustained for more than a couple of months.
This doesn’t seem like that now,” he said. “The real reason is the
labor market has been such a strong signal of economic strength that
it makes you question the GDP data.”

The rate hike was approved unanimously. In June, Kansas City Fed
President Esther George dissented, advocating a slower course with a
half percentage point increase.

The increases come in a year that began with rates floating around
zero but which has seen a commonly cited inflation measure run at 9.1%
annually. The Fed aims for inflation of around 2%, though it adjusted
that goal in 2020 to allow it to run a bit hotter in the interest of
full and inclusive employment.

Powell said the Fed is “strongly committed” to reducing inflation and
said that could come with a cost to general economic growth and the
labor market in particular.

“We think it is necessary to have growth slow down. Growth is going to
be slowing down this year for a couple of reasons,” he said. The
economy, he added, probably will grow below its long-run trend for a
period of time. “We actually think we need a period of growth below
potential in order to create some slack.”

In June, the unemployment rate held at 3.6%, close to full employment.
But inflation, even by the Fed’s standard of core personal consumption
expenditures, which was at 4.7% in May, is well off target.

The efforts to bring down inflation are not without risks. The U.S.
economy is teetering on the brink of a recession as inflation slows
consumer purchases and dents business activity.

First-quarter GDP declined by 1.6% annualized, and markets were
bracing for a reading on the second quarter to be released Thursday
that could show consecutive declines, a widely used barometer for a
recession. The Dow Jones estimate for Thursday’s reading is for a
growth of 0.3%.

Along with rate increases, the Fed is reducing the size of asset
holdings on its nearly $9 trillion balance sheet. Beginning in June,
the Fed began allowing some of the proceeds from maturing bonds to
roll off.

The balance sheet has declined just $16 billion since the beginning of
the roll-off, though the Fed set a cap of up to $47.5 billion that
potentially could have been wound down. The cap will rise through the
summer, eventually hitting $95 billion a month by September. The
process is known in markets as “quantitative tightening” and is
another mechanism the Fed uses to impact financial conditions.

Along with the accelerated balance sheet runoff, markets expect the
Fed to raise rates at least another half percentage point in
September. Traders Wednesday afternoon were assigning about a 53%
chance the central bank would go even further, with a third straight
0.75 percentage point, or 75 basis points, increase in September,
according to CME Group data.

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 by next summer, even
though committee projections released in June show no cuts until at
least 2024.

Multiple officials have said they expect to hike aggressively through
September and then assess what impact the moves were having on
inflation. Despite the increases — totaling 1.5 percentage points
between March and June — the June 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 hitting a record in a data
series going back to 1995.

The central bank has faced critics, both for being too slow to tighten
when inflation first started to accelerate in 2021 and for possibly
going too far and causing a more severe economic downturn.

Sen. Elizabeth Warren, D-Mass., told CNBC on Wednesday that she
worried the Fed hikes would pose an economic danger to those at the
lowest end of the economic spectrum by raising unemployment.

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