By CHRISTOPHER RUGABER, AP Business Writer
WASHINGTON (AP) — Stepping up its fight against high inflation, the Federal Reserve raised its key interest rate on Wednesday by a substantial three-quarters of a point for the third consecutive time and announced more rate hikes to come — a pace aggressive which will increase the risk of a possible recession.
The Fed’s decision raised its benchmark short-term rate, which affects many consumer and business loans, to a range of 3% to 3.25%, the highest level since early 2008.
Officials also forecast that they will raise their benchmark rate further to around 4.4% by the end of the year, one point higher than they had envisaged last June. And they expect to raise the rate again next year, to around 4.6%. It would be the highest level since 2007.
By raising borrowing rates, the Fed is making it more expensive to take out a mortgage or car or business loan. Consumers and businesses are likely to borrow and then spend less, which cools the economy and slows inflation.
Falling gasoline prices slightly lowered headline inflation, which was still a painful 8.3% in August from a year earlier. That drop in gas pump prices may have contributed to a recent boost in President Joe Biden’s approval ratings, which Democrats hope will improve their prospects in November’s midterm elections.
Speaking at a press conference, Chairman Jerome Powell said that before Fed officials consider halting their rate hikes, they “will want to be very confident that inflation is coming back down” to their 2% target. He noted that the strength of the labor market is fueling wage gains that are helping to drive up inflation.
And he underscored his belief that controlling inflation is key to ensuring the long-term health of the labor market.
“If we want to pave the way for another period of very strong labor markets,” Powell said, “we have to put inflation behind us. I wish there was a painless way to do that. ‘there is not any.
Fed officials said they were looking for a “soft landing”, whereby they would manage to slow growth enough to bring inflation under control, but not so much as to trigger a recession. Yet most economists are skeptical. They say they believe the Fed’s steep rate hikes will, over time, lead to job cuts, rising unemployment and a broad-based recession later this year or early next year. .
“No one knows if this process will lead to a recession, or if so, how big that recession would be,” Powell said at his press conference. “It will depend on how quickly we reduce inflation.”
In their updated economic forecasts, Fed policymakers expect economic growth to remain weak over the next few years, with rising unemployment. They expect the unemployment rate to reach 4.4% by the end of 2023, up from its current level of 3.7%. Historically, economists say, whenever unemployment has risen by half a point over several months, a recession has always followed.
Fed officials now forecast economic growth of just 0.2% this year, significantly lower than their growth forecast of 1.7% just three months ago. And they envision slow growth below 2% from 2023 to 2025.
Even with the big rate hikes planned by the Fed, it still expects core inflation – which excludes the volatile food and gas categories – to be 3.1% by the end of the month. next year, well above its 2% target.
Powell acknowledged in a speech last month that the Fed’s actions will “bring some pain” to households and businesses. And he added that the central bank’s commitment to bringing inflation back to its 2% target was “unconditional”.
Short-term rates at a level the Fed is now considering would make a recession more likely next year by sharply raising the costs of mortgages, auto loans and business loans. Last week, the average fixed mortgage rate rose above 6%, its highest level in 14 years, which explains why home sales fell. Credit card borrowing costs have reached their highest level since 1996, according to Bankrate.com.
Inflation now appears increasingly fueled by higher wages and consumers’ constant desire to spend and less by the supply shortages that had plagued the economy during the pandemic recession. On Sunday, Biden told CBS’s “60 Minutes” that he believed a soft landing for the economy was still possible, suggesting his administration’s recent energy and health care legislation would lower prices of pharmaceuticals and health care.
The law may help reduce prescription drug prices, but outside analysis suggests it will do little to immediately reduce headline inflation. Last month, the nonpartisan Congressional Budget Office ruled that this would have a “negligible” effect on prices through 2023. University of Pennsylvania’s Penn Wharton budget model went even further, saying that “the impact on inflation is statistically indistinguishable from zero” over the next decade. .
Even so, some economists are beginning to express concern that the Fed’s rapid rate hikes — the fastest since the early 1980s — will cause more economic damage than needed to bring inflation under control. Mike Konczal, an economist at the Roosevelt Institute, noted that the economy is already slowing and wage increases – a key driver of inflation – are stabilizing and, by some measures, even declining a little.
Polls also show that Americans expect inflation to come down significantly over the next five years. This is an important trend because inflation expectations can become self-fulfilling: if people expect inflation to fall, some will feel less pressure to accelerate their purchases. Less spending would then contribute to moderating price increases.
The Fed’s rapid rate hikes mirror actions taken by other major central banks, contributing to concerns about a possible global recession. The European Central Bank last week raised its key interest rate by three-quarters of a percentage point. The Bank of England, the Reserve Bank of Australia and the Bank of Canada have all made big rate hikes in recent weeks.
And in China, the world’s second largest economy, growth is already suffering from repeated government blockages. If the recession sweeps through most major economies, it could also derail the US economy.
Even at the accelerated pace of Fed rate hikes, some economists — and some Fed officials — say they have yet to raise rates to a level that would actually limit borrowing and spending and slow growth.
Many economists seem convinced that widespread layoffs will be needed to slow the rise in prices. A study released earlier this month under the auspices of the Brookings Institution concluded that unemployment may need to reach 7.5% to bring inflation back to the Fed’s 2% target.
“The risk is that the Fed will act more aggressively in its mission to bring inflation back to its 2% target, pushing the funds rate higher than expected and holding it longer,” Nancy Vanden Houten said. , chief US economist at Oxford Economics. , said Wednesday after the Fed meeting.
AP Economics Writer Paul Wiseman contributed to this report.
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