WASHINGTON (AP) – The Federal Reserve raised its benchmark interest rate by three-quarters of a point for the second time in a row on Wednesday in its most aggressive push in three decades to control high inflation.
The Fed’s 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 strenuous efforts to curb price gains across the economy. By raising borrowing rates, the Fed makes it more expensive to get a mortgage or a loan for a car or business. Then, presumably, consumers and businesses borrow and spend less, cooling the economy and curbing inflation.
The Fed is cutting credit even as the economy has begun to slow, raising the risk that rate hikes could trigger a recession later this year or next. Rising inflation and fears of a recession have eroded consumer confidence and stoked public anxiety about the economy, which is sending frustratingly mixed signals.
“I don’t think the United States is currently in a recession,” Chairman Jerome Powell said at a press conference on Wednesday.
As November’s midterm elections approach, Americans’ 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 moves to tighten credit sharply have torpedoed the real estate market, which is particularly sensitive to changes in interest rates. The average rate on a 30-year fixed mortgage has roughly doubled in the past year, to 5.5%, and home sales have fallen.
At the same time, consumers are showing signs of spending cuts in the face of high prices. And business surveys suggest sales are slowing.
The central bank is betting that it can slow growth just enough to control inflation, but not so much as 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 “spending and output indicators have softened,” “job gains have been robust in recent months and the unemployment rate has remained low.” The Fed tends to attach great importance to 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 this point, saying, “The Fed is not yet ready to acknowledge that weaker growth is a reason to slow the pace of tightening.”
On Thursday, when the government estimates gross domestic product for the April-June period, some economists believe it may show the economy contracted for a second straight quarter. This would fulfill a long-held assumption about when a recession has begun.
But economists say that would not necessarily mean a recession has begun. During the same six months when the global economy may have contracted, employers added 2.7 million jobs, more than in most entire years before the pandemic. Wages are also rising at a healthy pace, with many employers still struggling to attract and retain enough workers.
Still, slowing growth puts Fed policymakers in a high-stakes dilemma: How high should they raise borrowing rates if the economy is slowing? Weaker growth, if it leads to layoffs and increases unemployment, often reduces inflation on its own.
This dilemma could become even more consequential for the Fed next year, when the economy could be in worse shape and inflation will likely still exceed the central bank’s 2% target.
“How much recession risk are you willing to take to get (inflation) back to 2%, quickly, versus over the course of several years?” asked Nathan Sheets, a former Fed economist who is Citi’s global chief economist. “Those are the kinds of issues they’re going to have to contend with.”
Economists at Bank of America predict a “mild” recession later this year. Goldman Sachs analysts estimate a 50-50 chance of a recession within two years.
Among analysts predicting 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 sound financial shape, with more cash and less debt than after the housing bubble burst in 2008.
Fed officials have suggested that at its new level, its key short-term rate will neither stimulate nor constrain growth, what they call a “neutral” level. 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 rate hikes as early as the next meeting in September, perhaps by half a point. That increase, followed by possible quarter-point hikes in November and December, would still raise the Fed’s short-term rate to 3.25% to 3.5% by the end of the year, the most high since 2008.