Fed raises interest rates by .75 points to fight inflation

Fed raises interest rates by .75 points to fight inflation

Chair Jerome Powell on Sept. 21 said the Federal Reserve is raising its interest rate by three-quarters of a percentage point to tackle inflation. (Video: The Washington Post)

The Federal Reserve will not back down from its fight against inflation even though aggressive moves to slow the economy will inevitably bring pain to households and businesses nationwide, the central bank’s chief said Wednesday as the bank raised interest rates yet again.

“We have got to get inflation behind us,” Federal Reserve Chair Jerome H. Powell said. “I wish there were a painless way to do that. There isn’t.”

The message came after the central bank raised rates by 0.75 percentage points for the third time this year and released new economic projections showing a significant slowdown in the economy later in 2022 and 2023. People are suffering from high inflation — especially more vulnerable households, Powell said — and they’ll ultimately suffer more, and for longer, if the Fed flinches in its commitment to pulling prices back down.

That could mean a recession, job losses, higher credit costs or other unknown consequences. But Powell said letting inflation continue would be worse and that “delay is only likely to lead to more pain.”

The bank’s new projections — including for meager economic growth and rising unemployment — indicate that officials expect their year-long campaign to raise interest rates will have its intended effect soon. But Powell also said the Fed would “keep at it until it’s done” and gave no indication that the bank is ready to ease up on its policies.

“What they don’t want to be doing is halfway fighting inflation now, and then backing off and having to do it again when higher inflation expectations have become more entrenched,” said Stephanie Aaronson, vice president and director of the economic studies program at the Brookings Institution and a former Fed economist. “That would be very painful.”

Why does the Fed raise interest rates?

This month’s rate hike was the fifth of the year, and the third consecutive three-quarter point hike. Such an increase would have been considered outlandishly large until recently. But the Fed has been in a race to push rates past the “neutral” zone of roughly 2.5 percent, where rates don’t slow or juice the economy, and into “restrictive territory” that dampens consumer demand. The Fed’s benchmark interest rate now sits between 3 percent and 3.25 percent, and officials expect it to cross 4 percent by the end of the year, well into what’s considered restrictive. That rate doesn’t directly control rates for mortgages and other loans, but it influences how much banks and other financial institutions pay to borrow, which helps drive loan pricing more broadly.

The sharp rate hikes also reflect central bank officials’ missteps in identifying the threat inflation posed to the economy. The Fed held off on raising rates last year, with Powell and other top Fed leaders saying they believed that the slow creep in inflation throughout 2021 would be temporary. Since it became clear they were wrong, policymakers have had to catch up to inflation that rapidly escalated beyond their control.

The markets have been especially anxious about a looming recession and the Fed’s promises of higher rates. Stocks tumbled in volatile trading Wednesday, with major stock market indexes all dropping about 1.7 percent after some swings in both directions.

Traders in financial markets also appear wary that the Fed’s moves, combined with those of other central banks, are steering the global economy toward a recession. The Fed is among at least eight central banks expected to raise borrowing costs this week, and economists are becoming increasingly worried that many nations’ economies won’t be able to withstand such an extreme slowdown.

Global economy weakening amid inflation fight, war and lingering pandemic

Powell made clear that Fed officials are not seeing anywhere near the kind of progress necessary to say its policies are taking hold. But the housing market, which is particularly sensitive to higher rates, may be a sign that its moves are starting to work. Mortgage rates have escalated in recent months, and Wednesday’s announcement could mean even higher mortgage rates in the coming weeks. The interest rate for a 30-year fixed mortgage, the most popular home loan, spiked above 6 percent last week for the first time in 14 years, according to data from Freddie Mac.

Fed watchers and market analysts also got some sense of what the bank expects through its latest set of economic projections, which are revised every three months. The last time the Fed released projections, in June, it forecast that the economy would grow 1.7 percent in 2022. That figure was revised down significantly, to 0.2 percent.

Officials also expect inflation will remain high at the end of the year — 5.4 percent using the Fed’s preferred gauge, which was at 6.3 percent in July — before falling closer to normal levels next year.

On future rate hikes, Fed officials penciled in another increase of three-quarters of a percentage point and one half-point hike for the two remaining meetings of the year. The projections also show rates climbing slightly next year before cuts in 2024. But Powell noted that the bank makes decisions one meeting at a time.

“No one knows with any certainty where the economy will be a year or more from now,” he said.

So far, the job market and consumer spending — two crucial economic engines — have stayed resilient through the Fed’s sharp rate hikes. But Powell has warned before that the fight for price stability will probably mean that the job market will soften. Officials expect the unemployment rate, currently 3.7 percent, will end the year at 3.8 percent before rising to 4.4 percent by the end of 2023.

That would typically also portend a recession, which generally follows whenever the unemployment rate climbs by a half-percentage point or more.

Labor market added 315,000 jobs in August, a bright spot in the economy

In an analyst note, Joe Brusuelas, chief economist at RSM, gave a bleaker assessment of where the job market may be headed. He estimates that for inflation to come down to 3 percent — which is still higher than the Fed’s target of 2 percent — the unemployment rate could go up to 4.7 percent and lead to a loss of 1.7 million jobs.

“To get the inflation rate back to 2 percent, job losses could land well above 5.3 million and result in an unemployment rate of 6.7 percent at the upper end of the range,” Brusuelas wrote.

Fed projections are often wrong, and any estimates tend to be a subpar match for the uncertainty of the coronavirus era. Russia’s invasion of Ukraine caused a global energy crisis that pushed inflation even higher. Ongoing supply chain issues, plus an out-of-whack job market, have made it more difficult for the Fed to solve inflation with rate hikes alone.

Wendy Edelberg, director of the Hamilton Project and former chief economist at the Congressional Budget Office, said the specific projections ultimately matter less than Powell’s overarching point that “regardless of whatever we’ve written down, we will do enough because we just will.”

“The most important question is, are they going to do enough to slow inflation?” Edelberg said. “And the answer is ‘yes.’”

Abha Bhattarai, David J. Lynch and Hamza Shaban contributed to this report.

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