WASHINGTON – WASHINGTON (AP) – The Federal Reserve on Wednesday raised its benchmark interest rate by three-quarters of a point for the second straight time in its most aggressive campaign in three decades to rein in high inflation.
The Fed move will raise its key rate, which affects many consumer and business loans, to a range of 2.25% to 2.5%, its highest level since 2018.
The central bank’s decision follows a jump in inflation to 9.1%, the fastest annual rate in 41 years, and reflects its arduous efforts to curb price gains across the economy. By raising lending rates, the Federal Reserve makes it more expensive to get a mortgage, car or business loan. So consumers and businesses presumably borrow and spend less, cooling the economy and slowing inflation.
The Fed is tightening credit even as the economy has started to slow, raising the risk that its rate hikes will spark a recession later this year or next. Rising inflation and fears of a recession have eroded consumer confidence and sparked public anxiety about the economy, which is sending mixed and frustrating signals.
As the November midterm elections approach, American discontent has lowered President Joe Biden’s public approval ratings and increased the likelihood that Democrats will lose control of the House and Senate.
The Fed’s actions to drastically restrict credit have torpedoed the housing market, which is especially sensitive to changes in interest rates. The average rate on a 30-year fixed mortgage roughly doubled last year, to 5.5%, and home sales plummeted.
At the same time, consumers are showing signs of cutting corners in the face of high prices. And business surveys suggest sales are slowing.
The central bank is betting it can slow growth enough to rein in inflation but not enough to trigger a recession, a risk many analysts fear could end badly.
In a statement the Fed issued after its latest policy meeting ended, it acknowledged that while “output and spending indicators have softened,” “job gains have been strong in recent months and the unemployment rate has has kept low. The Federal Reserve generally places great importance on the pace of hiring and wage growth because when more people earn paychecks, the resulting spending can fuel inflation.
Ian Shepherdson of Pantheon Macroeconomics made that point, saying: “The Federal Reserve is not ready, yet, to admit that weaker growth is a reason to slow the pace of adjustment.”
On Thursday, when the government estimates gross domestic product for the April-June period, some economists believe it may show the economy contracted for the second consecutive quarter. That would meet a longstanding assumption for when a recession has started.
But economists say that doesn’t necessarily mean a recession has begun. During those same six months in which the overall economy might have contracted, employers added 2.7 million jobs, more than in most years before the pandemic. Wages are also rising at a healthy pace, and many employers are still struggling to attract and retain enough workers.
Still, slowing growth puts Fed policymakers in a high-stakes dilemma: How far should they raise interest rates if the economy is slowing? Weaker growth, if it leads to layoffs and increases unemployment, often lowers inflation on its own.
That dilemma could become an even bigger one for the Fed next year, when the economy may be in worse shape and inflation is likely to exceed the central bank’s 2% target.
“How much recession risk are you willing to take to get (inflation) back to 2%, quickly, compared to over several years?” asked Nathan Sheets, a former Fed economist who is chief global economist at Citi. “That’s the kind of issues they’re going to have to deal with.”
Bank of America economists forecast a “mild” recession later this year. Analysts at Goldman Sachs estimate a 50-50 chance of a recession within two years.
Among analysts forecasting a recession, most predict it will be relatively mild. The unemployment rate, they note, is near a 50-year low and households are generally in solid financial shape, with more cash and smaller debts than after the housing bubble burst in 2008.
Fed officials have suggested that at their new level, their key short-term rate will neither stimulate growth nor restrain it, what they call a “neutral” level. Chairman Jerome Powell has said the Fed wants its key rate to reach neutral relatively quickly.
If the economy continues to show signs of slowing, the Fed may moderate the size of its rate hikes as early as its next meeting in September, perhaps by as much as half a point. Such an increase, followed by possible quarter-point hikes in November and December, would still lift the Fed’s short-term rate from 3.25% to 3.5% by the end of the year, the highest point since 2008.