The Federal Reserve moved to tamp down soaring inflation in the US on Wednesday, announcing the sharpest rise in interest rates in over 20 years.
The Fed’s benchmark interest rate was raised by 0.5 percentage points to a target rate range of between 0.75% and 1%. The hike is the largest since 2000 and follows a 0.25 percentage point increase in March, the first increase since December 2018.
More rate rises are expected. The Economist Intelligence Unit expects the Fed to raise rates seven times in 2022, reaching 2.9% in early 2023. Starting in June, officials also plan to shrink their $9tn asset portfolio, a policy move that will further push up borrowing costs.
In a statement the Fed said that although “overall economic activity edged down in the first quarter, household spending and business fixed investment remained strong”. But it warned that inflation “remains elevated”, the invasion of Ukraine had implications for the US economy that remain “highly uncertain” and Covid-related lockdowns in China “are likely to exacerbate supply chain disruptions”.
Rates were cut to near zero in March 2020 when the pandemic hit the US but they were already low and years of low rates left the US and other countries ill-prepared for a sudden rise in inflation. Until recently the Fed had dismissed rising prices as “transitory” and expected them to fall as economies recovered from the pandemic.
All that has now changed. The Fed chair, Jerome Powell, took the unusual step of addressing the American people at the start of a press conference following the rate hike announcement. “Inflation is much too high, and we understand the hardship it is causing. We are moving expeditiously to bring it back down,” he said.
“Some of us are old enough to have lived through high inflation and many aren’t. But it’s very unpleasant … If you are a normal economic person, then you probably don’t have that much extra to spend, and it’s immediately hitting your spending on groceries, on gasoline, on energy, things like that. We understand the pain involved.”
Thanks in large part to the unprecedented impact of the coronavirus on the global economy, inflation is now running at a 40-year high in the US. In March, the Consumer Price Index (CPI) was 8.5% higher than it was a year ago, driven up by rising prices for gasoline, shelter, and food. The increasing costs of essential goods and services are now outstripping average wage gains.
Ahead of the announcement Jamie Dimon, JP Morgan Chase chief executive officer, warned that the Fed may have waited too long to raise rates. “We’re a little late,” he told Bloomberg. “The sooner they move the better.”
The impact of the Fed’s policy is already being felt in the wider economy. Since the start of the year, mortgage rates have climbed at their fastest pace in decades, rising nearly two percentage points. Some hot property markets have started to cool as a result. The impact of tighter monetary policy has also triggered selloffs in the stock markets.
Powell said the economy remained strong and that he was confident the Fed could act without triggering a recession but he warned it would act aggressively to tackle inflation.
“We need to do everything we can to restore stable prices,” he said. “We will do it as quickly and effectively as we can. We think we have a good chance to do it without significant increase in unemployment or sharp slowdown. But ultimately, we think about the medium and longer term, and everyone will be better off if we can get this job done – the sooner, the better.”