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Fed could discuss biggest interest rate hike since 1994


Inflation is picking up and proving more tenacious than policymakers hoped.

The US Treasury building in Washington, DC on May 22. Joshua Roberts/Bloomberg

The Federal Reserve is expected to discuss its largest interest rate hike since 1994 at its meeting this week as a slew of new data suggests inflation is intensifying and proving more tenacious than policymakers expect. had hoped.

Central bankers have vowed to be nimble in their fight against inflation – a stance that will likely prompt them to at least discuss whether to raise interest rates by three-quarters of a percentage point on Wednesday, when the officials are expected to release both their decision and a new set of economic projections.

The Fed raised rates by half a percentage point in May and officials had suggested for weeks that a similar increase would be warranted at their June and July meetings if the data developed as expected. But costs did not behave as expected.

Instead, a report last week showed inflation re-accelerating in May and running at the fastest pace since 1981. Of them separate measures of inflation expectations, one released last week and another released on Monday, showed that consumers were beginning to expect prices to rise significantly faster.

This is sure to increase the sense of unease within the Fed, which is trying to quell high inflation before it changes its behavior and becomes a more permanent feature of the economic backdrop. Fed Chairman Jerome Powell and other officials have repeatedly stressed the need to bring prices back to a stable level to ensure a healthy economy. The series of worrying news has economists and investors betting that the central bank will start raising interest rates faster to signal that it recognizes the problem and is making tackling inflation a priority.

“They have made it clear that they want to prioritize price stability,” said Pooja Sriram, US economist at Barclays. “If that is their plan, a more aggressive political stance is what they need to do.”

Wall Street is bracing for interest rates to rise more than investors expected just days ago, a reality that is sending stocks tumbling and causing other markets to bleed, including the crypto market. -currencies. Investors now expect rates to rise to a range of 2.75% to 3% beginning with the Fed rally in September, from their current range of 0.75% to 1%.

That suggests central bankers should make two three-quarter point moves in its next three meetings. The Fed hasn’t made such a big hike since the early 1990s, and that 3% upper limit would be the highest the federal funds rate has been since the 2008 global financial crisis.

Such an abrupt policy would have big implications for the economy. When the Fed raises its key interest rate, it infiltrates the economy to make borrowing of all kinds – including mortgage debt and business loans – more expensive. This slows the housing market, prevents consumers from spending as much, and hampers business expansion, weakening the job market and the economy in general. Slower demand can help ease price pressures as fewer buyers compete for goods and services.

But interest rates are a blunt tool, making it difficult for the Fed to slow the economy with precision. Likewise, it is difficult to predict how much conditions need to cool to bring inflation down convincingly. Pandemic-related supply issues could ease, allowing for a deceleration. But the war in Ukraine and China’s recently reimposed lockdowns meant to contain the coronavirus could keep prices high.

Households, economists and investors are increasingly concerned that the central bank could trigger a recession, and worries of a coming slowdown ricocheted through markets on Monday.

Stock indices fell sharply around the world throughout the day, and a signal from the bond market that traders are watching closely now suggests a slowdown may be on its way. The yield on the two-year Treasury bill, a benchmark for borrowing costs, briefly topped the 10-year yield on Monday. This so-called inverted yield curve, when it costs more to borrow for shorter periods than for longer periods, generally does not occur in a healthy economy and is often taken as a sign of a impending recession.

While the economy is strong now, a recession that wipes out some of the recent strong progress in the job market would be bad news for President Joe Biden, whose approval ratings have already waned amid rising unemployment. inflation.

Yet the White House has been quick to stress that the Fed is independent and will respect its ability to do what it deems necessary to bring inflation under control. Biden, in a recent opinion column, acknowledged that the nation is about to enter a period of transition.

“The Federal Reserve has the primary responsibility for controlling inflation,” Biden wrote. He added that “past presidents sought to influence his decisions inappropriately during times of high inflation. I will not do that.

The Fed has a two-part mandate to achieve both stable prices and maximum employment. But officials have increasingly stressed that a strong labor market with runaway price increases is far from stable and that keeping inflation under control is a prerequisite for a truly healthy labor market.

Getting prices under control has seemed like an increasingly thorny challenge as wage growth remains strong, consumers continue to spend at a rapid pace and families are beginning to think the price hikes might last. In the 1970s, economists say, Americans began to expect faster inflation and demand bigger wage increases, setting off a chain reaction that fueled itself and drove prices ever higher. upper.

Coupled with the possibility that uncontrollable shocks will continue to drive up prices – for example, the war in Ukraine is expected to continue driving up commodity prices – the latest developments have placed the Fed in a difficult position.

“We cannot allow a wage price spiral to occur, and we cannot allow inflation expectations to become unanchored,” Powell said at a news conference with reporters after the meeting. May from the central bank. “It’s just something we can’t allow.”

The Fed has been in its pre-meeting blackout period, during which its officials do not comment on monetary policy, for several key data releases – including the latest hot inflation reading. That left Wall Street wondering whether its officials might consider accelerating the process.

But the central bank’s buzzwords for the year were “nimble” and “humble,” terms Powell repeatedly emphasized.

“This is where it’s important to be nimble,” said Diane Swonk, chief economist at Grant Thornton. “A 75 basis point move would underscore their commitment to avoiding the mistakes of the 1970s.”

This article originally appeared in The New York Times.


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