Interest rates

The Fed raises interest rates for the first time since 2018

The Federal Reserve has said it will raise interest rates and has planned a series of further increases this year aimed at preventing the economy from overheating and reducing inflation which is at its highest level in four decades.

Fed officials said on Wednesday they would raise their benchmark federal funds rate by a quarter of a percentage point to a range between 0.25% and 0.5% from near zero, and the most of them planned to raise it to at least the level that prevailed before the pandemic hit the US economy two years ago.

In a statement after its two-day meeting, the Fed hinted at growing concern about inflationary pressures. He said inflation was high due to “broader price pressures” and added that the war in Ukraine and “related events are likely to create additional upward pressure on inflation,” according to the press release.

The Federal Open Market Committee responsible for setting rates approved the decision by an 8-1 vote, with St. Louis Fed President James Bullard dissenting in favor of a larger half-a-half hike. percentage point.

The Federal Reserve’s primary tool for managing the economy is changing the federal funds rate, which can affect not only borrowing costs for consumers, but also influence broader business decisions, such as the number of people to hire. The WSJ explains how the Fed manipulates this single rate to guide the entire economy. Illustration: Jacob Reynolds

The statement also signaled that the Fed may soon announce and implement a plan to reduce its asset portfolio by $9 trillion. The central bank ended a long-running asset-purchase stimulus program last week.

New projections show most officials expect the fed funds rate to hit at least 1.875% by the end of this year, according to the median of 16 officials, to about 2.75% by the end of this year. the end of 2023 and keep rates there in 2024. That means a total of seven quarter-percentage-point increases this year and three or four more next year.

That’s a much faster pace than officials had expected in December, when most officials projected rate increases of three-quarters of a percentage point for this year, and considerably faster than a series of nine interest rate increases between 2015 and 2018. That would be closer to the 2004-2006 period, when the Fed raised rates 17 times in a row.

Seven officials predicted that the Fed would raise rates at a pace that would imply that at least one of its actions this year would be a half-percentage-point hike.

The federal funds rate, an overnight rate on interbank lending, influences other borrowing costs for consumers and businesses across the economy, including rates for mortgages, credit cards credit, savings accounts, car loans and business debt. Raising rates generally limits spending, while lowering rates encourages such borrowing.

The magnitude of the rise in other interest rates will depend on the reaction of investors, businesses and households.

The Fed’s decision on Wednesday marked a sharp turnaround from just two years ago, when it cut rates to near zero and launched a series of programs to stabilize markets and support the economy amid Covid -19 was shutting down large swaths of the economy. The pandemic triggered a severe two-month recession in 2020 and record job losses.

Since then, economic output has picked up thanks to massive federal stimulus and vaccinations, and inflation jumped a year ago. The recent episode is a far cry from the seven years of near-zero interest rates the Fed maintained after the 2008 financial crisis.

Inflation rose 6.1% in January from a year earlier, according to the Fed’s preferred gauge. Core inflation, which includes food and energy, rose 5.2%. Most officials now see core inflation ending the year at 4.1%, up from their forecast of 2.7% in December. They see interest rate hikes bringing inflation down further, to 2.6% at the end of 2023 and 2.3% the following year.

Even before Russia’s invasion of Ukraine three weeks ago, Fed officials had worried that inflation might not come down as quickly as they had predicted a while ago. a few months old. US labor markets have tightened rapidly, with the jobless rate falling to 3.8% in February and annual wage growth hitting its fastest pace in years.

Now officials face the prospect of even higher inflation as the West escalates sanctions against Moscow, which risks pushing up energy and commodity prices, as well as new pandemic lockdowns in China that further disrupt global supply chains.

Interest rate futures markets show that investors are already expecting the Fed to hike rates at its next two meetings, in May and June.

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Earlier this month, Powell laid the groundwork for the possibility of raising rates by half a percentage point later this year, rather than in quarter-point increments. He also suggested that the Fed may eventually have to raise rates to a level designed to deliberately slow economic growth.

Economists say there is a growing risk that Mr Powell will feel pressure to raise rates to levels that tip the economy into recession. This would be particularly the case if policymakers conclude that consumer and business expectations of future inflation are rising or if officials see growing evidence of a price-wage spiral in which workers facing rising prices require more wage increases, leading companies to continue rising prices.

The last time inflation was this high, the Federal Reserve raised rates so much that it plunged the United States into a recession. Will we see a repeat of this today? The WSJ’s Dion Rabouin explains why the Fed’s next steps are crucial. Photo: Kevin Dietsch/Getty Images

Fed officials face three important questions as they consider their next moves. First, how quickly should they raise rates to an estimated “neutral” level that neither accelerates nor slows growth? Second, has this neutral level increased as rising inflation drives down real or inflation-adjusted borrowing costs? And third, if and when will the Fed need to raise rates above neutral to deliberately slow growth?

Late last year, many Fed officials thought they might just need to raise the fed funds rate to a neutral level. Most officials estimate that to be between 2% and 3% when core inflation — stripped of idiosyncratic influences such as supply shocks — is at the Fed’s 2% target.

Some economists are warning that a period of higher inflation could force the Fed to raise the rate to the 4-5% range that prevailed in the two decades before the 2008 financial crisis. That could surprise investors who bet on real estate, stocks, bonds and other assets by counting on inflation and perpetually low interest rates.

The central bank has repeatedly telegraphed its shift to a rate hike this year, and already mortgages and other borrowings have become more expensive. The average 30-year fixed-rate home loan topped 4.25% last week, according to the Mortgage Bankers Association, an increase of nearly a full percentage point since late last year, and lenders have said rates had risen further in recent days.

Write to Nick Timiraos at [email protected]

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