The Fed keeps the pressure on with another ‘unusually large’ 0.75% rate hike as economy starts to cool

The Fed keeps the pressure on with another ‘unusually large’ 0.75% rate hike as economy starts to cool

Having long since abandoned the notion that inflation would be a short-lived phenomenon, the Federal Reserve hiked its benchmark interest rate on Wednesday by another three-quarters of a point.

A repeat of last month’s increase — which Federal Reserve Chair Jerome Powell called “unusually large” — the latest hike is the central bank’s fourth this year as it tries to pull down prices that have been soaring out of control.

“Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices and broader price pressures,” the decision-making Federal Open Market Committee says in a release.

“Russia’s war against Ukraine … and related events are creating additional upward pressure on inflation and are weighing on global economic activity.”

The most recent inflation measure showed prices rising at their fastest pace in over 40 years, triggering some market watchers to bet the Fed would go even higher with a full percentage point rate hike at this week’s meeting. Doing so would have mirrored the Bank of Canada, which increased its own rate 1% earlier this month.

The central bank’s latest move brings its new target to between 2.25% and 2.50%.

While Americans will feel the increase in the form of higher borrowing costs for cars, homes and credit, consumers are starting to feel optimistic that prices will finally come down.

Don’t miss What’s behind the higher rates

The University of Michigan’s Consumer Sentiment Survey, a report the Fed has used to guide its policies, shows Americans are finally easing their expectations for inflation, even if their overall outlook remains sour.

Story continues

Powell and his fellow policymakers are under unrelenting pressure to continue hiking rates. If you’ve looked for a house or apartment lately, filled your gas tank or spent any time at the grocery store, you’re all too familiar with the reason why.

The most recent Consumer Price Index — a key measure of inflation — rose 9.1% in June from the same month last year, the Labor Department reported.

While some of the higher costs are a result of supply-chain bottlenecks and other factors the Fed can’t control, the bank can get in the way of demand.

The Fed rate — called the federal funds rate or the “target for the overnight rate” — is an important tool for cooling off the economy. It’s the interest rate banks charge each other for overnight loans so they can meet their requirements for cash on hand.

When banks pay more to borrow, they pass on those costs to the rest of us, thus reducing our buying power and demand for goods and services. It’s all part of the central bank’s so-called dual mandate, which aims for full employment and stable prices with inflation at around 2%.

How are borrowing costs being affected?

Interest rates have been rising swiftly since the Fed began tightening its policies earlier this year.

The rate on a 30-year mortgage is nearly twice what it was last year.

Credit card rates are heading north, too — now averaging over 17%. Year over year, the average annual percentage rate (APR) for a new credit card is up by 1.3 percentage points — the biggest increase in more than a decade, according to CreditCards.com.

Most credit cards (and adjustable-rate mortgages) are tied to the prime rate, and when the Fed rate moves, so does the prime.

Are we in a recession or not?

Analysts have been debating whether the U.S. is in — or just dangerously close to — a recession, which is traditionally signaled by consecutive quarters of negative economic growth.

While the next gross domestic product (GDP) announcement is likely to mark the second straight quarter of negative growth, the situation is quite different this time around, says Mark Zandi, chief economist for Moody’s Analytics.

During the first half of the year, layoffs were near record lows and job growth was ripping.

“While we are not in recession,” Zandi tweeted, while acknowledging that “recession risks are uncomfortably high.”

The National Bureau of Economic Research — which Zandi and other economists call the all-but-official word on when the U.S. is in a recession — simply defines it as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

How effective are the Fed’s actions?

“Recent indicators of spending and production have softened,” the central bank said in Wednesday’s announcement. “Nonetheless, job gains have been robust in recent months, and the unemployment rate has remained low.”

Mixed economic signals have put the Fed in a challenging spot.

“The bank argued for the better part of 2021 that inflation was ‘transitory’ and likely to recede once the supply-chain bottlenecks were resolved, only to admit earlier this year that aggressive policy action was needed to remedy accelerating prices,” said George Ratiu, senior economist with Realtor.com.

Massachusetts Sen. Elizabeth Warren has criticized the Fed’s approach, saying it will cost millions of jobs and make it more expensive for businesses to grow.

The Fed’s aggressive rate hikes are “largely ineffective against many of the underlying causes of this inflationary spike,” she wrote in the Wall Street Journal.

Will the Fed remain aggressive on rates?

Last month, the Fed hiked its rate by three-quarters of a point, which was the biggest rate hike since 1994.

More hikes are sure to follow, as the Fed expects its median rate to be 3.4% by the end of the year.

Economists at ING believe this will be the last 0.75% hike and that future increases will be lower.

“Recent falls in gasoline prices have offered some encouragement that 9.1% probably marks the peak for U.S. inflation, but it is set to remain stubbornly high for at least the next six months,” ING suggests.

“There is little sign of easing price pressures surrounding food and surging airline fares, while the lagged effects of a red-hot property market continue to feed through into the housing components. The strong jobs numbers recorded in recent months with unemployment at just 3.6% also point to more rate hikes ahead.”

Will anything good come out of the rate hike?

Americans with money in savings accounts have watched their balances stagnate since the Fed cut rates to almost zero.

Now that they’re going back up, average interest rates on savings and money market accounts are likely to as well.

“We should soon see deposit rates rise to the levels that we saw in January and February of 2019,” writes Ken Tumin, founder of DepositAccounts.com, citing the last rate hiking cycle that ended in December 2018.

“In fact, deposit rates should rise higher since there are strong expectations of future Fed rate hikes for the rest of this year.”

What to read next

This article provides information only and should not be construed as advice. It is provided without warranty of any kind.