Borrowing costs

Fed tackles inflation with biggest rate hike since 1994; borrowing costs soar | Economic news

On Wednesday, the Federal Reserve stepped up its efforts to rein in high inflation by raising its key interest rate by three-quarters of a point — its biggest hike in nearly three decades — and signaling bigger rate hikes to come. which would increase the risk of another recession. .

The decision announced by the Fed after its last policy meeting will increase its benchmark short-term rate, which affects many personal and business loans, to a range of 1.5% to 1.75%. With the additional rate hikes they are planning, policymakers expect their key rate to reach a range of 3.25% to 3.5% by the end of the year – the highest level since 2008 – meaning most forms of borrowing will become significantly more expensive.

Rise in inflation

The central bank is stepping up efforts to tighten credit and slow growth as inflation hit a four-decade high of 8.6%, spreading to more parts of the economy and showing no signs of slowing. Americans are also starting to expect high inflation to last longer than before. This sentiment could embed an inflationary psychology in the economy that would make it more difficult for inflation to return to the Fed’s 2% target.

The Fed’s three-quarter-point rate hike tops the half-point hike that Chairman Jerome Powell had previously suggested and is expected to be announced this week. The Fed’s decision to impose a rate hike as large as it did on Wednesday was an acknowledgment that it is struggling to curb the pace and persistence of inflation, which has been aggravated by the war. of Russia against Ukraine and its effects on energy prices.

Asked at a press conference on Wednesday why the Fed was announcing a more aggressive rate hike than it had announced before, Powell replied that the latest reports had shown inflation to be higher than intended.

“We thought strong action was warranted at this meeting,” he said, “and we did.”

Political repercussions

Inflation rose to the top of voters’ concerns in the months leading up to the midterm congressional elections, degrading public opinion on the economy, weakening President Joe Biden’s approval ratings and increasing the likelihood of Democratic losses in November. Biden has sought to show he recognizes the pain inflation is causing American households, but has struggled to find policy actions that could make a real difference. The president underscored his belief that the power to curb inflation rests primarily with the Fed.

Yet the Fed’s rate hikes are blunt tools in an attempt to reduce inflation while supporting growth. Shortages of oil, gasoline and food propel inflation. The Fed isn’t ideal for tackling many of the causes of inflation, which involve Russia’s invasion of Ukraine, still-clogged global supply chains, labor shortages work and a growing demand for services, from airline tickets to restaurant meals.

Borrowing costs have already risen sharply across much of the US economy in response to Fed decisions, with the average 30-year fixed mortgage rate topping 6%, its highest level since before the 2008 financial crisis, against only 3% at the beginning. of the year. The yield on the 2-year Treasury note, a benchmark for corporate borrowing, jumped to 3.3%, its highest level since 2007.

Future job losses?

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Even if a recession can be avoided, economists say it’s almost inevitable that the Fed will have to inflict some pain — most likely in the form of higher unemployment — as the price for beating chronically high inflation.

In their updated forecast on Wednesday, Fed policymakers indicated that after this year’s rate hikes, they expect two more rate hikes by the end of 2023, when they expect that inflation finally falls below 3%, close to their target of 2%. But they expect inflation to still be 5.2% at the end of this year, well above what they estimated in March.

Over the next two years, officials forecast a much weaker economy than expected in March. They expect the unemployment rate to reach 3.7% by the end of the year and 3.9% by the end of 2023. These are only slight increases from the rate of current unemployment of 3.6%. But it’s the first time since it started raising rates that the Fed has acknowledged its actions will weaken the economy.

The central bank also sharply lowered its economic growth projections, to 1.7% this year and next. That’s below its March outlook, but better than some economists’ expectations for a recession next year.

Expectations of bigger Fed hikes sent a range of interest rates to their highest levels in years. The yield on the 2-year Treasury note, the benchmark for corporate bonds, reached 3.3%, its highest level since 2007. The 10-year Treasury yield, which directly affects mortgage rates, reached 3, 4%, up almost half a point since last week and the highest level since 2011.

Markets are collapsing

Investments around the world, from bonds to bitcoin, have fallen on fears surrounding high inflation and the prospect that the Fed’s aggressive drive to control it will cause a recession. Even if the Fed pulls off the trick of reining in inflation without triggering a recession, rising rates will still put pressure on stock prices. The S&P 500 has already fallen more than 20% this year, meeting the definition of a bear market.

Other central banks are also moving quickly to try to contain soaring inflation, even though their countries are more at risk of recession than the United States. The European Central Bank is expected to raise rates by a quarter point in July, its first increase in 11 years. It could announce a bigger rise in September if record inflation levels persist. On Wednesday, the ECB pledged to create a market safety net that could protect member countries against financial turmoil of the kind that erupted in a debt crisis more than a decade ago.

The Bank of England has hiked rates four times since December to a 13-year high, despite forecasts that economic growth will remain flat in the second quarter. The BOE will hold an interest rate meeting on Thursday.

Last week, the World Bank warned of the threat of “stagflation” – slow growth accompanied by high inflation – in the world.

One of the main reasons a recession is now more likely is that economists increasingly believe that for the Fed to slow inflation to its 2% target, it will have to cut consumer spending sharply, earnings wages and economic growth. Ultimately, the jobless rate will almost certainly have to rise — something the Fed has yet to forecast, but may do in updated economic projections it will release on Wednesday.

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