The Federal Reserve continued its fight against high inflation Wednesday by raising key interest rates by a quarter, the eighth increase since March. And the Fed has signaled that even if inflation is easing, it remains high enough to require further rate hikes.
The central bank’s latest move puts the benchmark short-term rate in the range of 4.5% to 4.75%, the highest level in about 15 years. While smaller than previous increases — and larger rate hikes before — the latest move will increase the cost of many consumer and business loans and the risk of a recession.
In a statement, Fed officials repeated language they’ve used since March that said, “continued increases in the target (interest rate) range would be appropriate.” That appears to be a signal that they intend to raise benchmark rates again when they meet in March and possibly in May.
The Fed’s hike was announced a day after the government reported that wages and benefits for American workers grew slowly in the last three months of 2022, the third straight decline. The report could help convince the Fed that wage gains won’t lead to higher inflation.
Speculation is rife among Wall Street investors and many economists that with inflation continuing to cool, the Fed will decide to end its aggressive drive to tighten credit. When they last met in December, Fed policymakers thought they would eventually raise the benchmark rate to a range of 5% to 5.25%. The rate requires two additional quarter-point increments.
But Wall Street investors have priced in just one more hike. Collectively, in fact, they expect the Fed to reverse course and actually cut rates later this year. That optimism helped boost stock prices and bond yields, shrinking credit and pushing in the opposite direction the Fed wanted.
The separation between the Fed and the financial markets is important because rate hikes must take place in the markets to affect the economy. The Fed directly controls key short-term rates. But it has only indirect control over the level of debt that people and businesses pay – for mortgages, corporate bonds, car loans and so on.
The result can be seen at home. The average fixed rate on a 30-year mortgage rose after the Fed first started hiking rates. In the end, it was at the top of 7%, more than twice where he stood before the hike began.
But since the fall, the average mortgage rate has decreased to 6.13%, the lowest rate since September. And while home sales fell again in December, the size of contracts signed to buy homes actually increased. That suggests that lower rates could attract some homebuyers back into the market.
Over the past several months, Fed officials have scaled back the size of rate hikes, from a remarkable four three-quarter-point hikes in a row last year to a half-point hike in December to Wednesday’s quarter-point hike.
The more gradual pace is intended to help the Fed navigate what will be high-risk decisions this year. The decline in inflation indicates that rate hikes have begun to achieve their goals. But the inflation rate is still far from the central bank’s 2% target. The risk is that with some sectors of the economy weakening, higher borrowing costs could push the economy into recession later this year.
Retail sales, for example, have fallen for two straight months, suggesting that consumers are becoming more cautious about spending. Manufacturing output has fallen for two months. On the other hand, the country’s labor market – the most important pillar of the economy – remains strong, with the unemployment rate at a 53-year low of 3.5%.
Last year, with businesses rapidly raising wages to try to attract and retain enough workers, Powell expressed concern that wage growth in the labor-intensive service sector would keep inflation too high. Businesses typically pass on increased labor costs to customers by charging higher prices, thus maintaining inflationary pressures.
But recent measures show that wage growth is slowing. And in December, overall inflation eased to 6.5% in December from a year earlier, down from a four-decade peak of 9.1% in June. The decline was driven by cheaper gas, which dropped to $3.50 a gallon, on average, nationwide, from $5 in June.
Supply chain reserves have also been cleared, which has led to lower prices of manufactured goods. Used car prices, which have risen in the pandemic amid a shortage of cars, have now fallen for several months.
Other major central banks are also fighting high inflation with rate hikes. The European Central Bank is expected to raise its benchmark rate by half a point when it meets Thursday. Inflation in Europe, although slow, remains high, at 8.5% in January compared to the previous year. Food and energy costs have caused price spikes across the continent after Russia’s invasion of Ukraine has disrupted energy markets and is still affecting consumers’ utility bills.
The Bank of England will also raise rates at its Thursday meeting as well. Inflation has reached 10.5% in the UK. The International Monetary Fund has forecast that the UK economy will enter recession this year. He expects the US and the 20-nation euro zone to grow modestly.
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