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, the latest hike is the Fed's fourth this year as it tries to pull down prices that have been soaring out of control. The vote on the increase was unanimous, as Chairman Jerome Powell pointed to a worse-than-expected inflation reading earlier this month.
“We know inflation is too high and how painful it is, particularly for people living paycheck to paycheck,” Powell said at the announcement.
Prices are 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.
While the larger hike wasn’t on the table this month, another “unusually large increase could be appropriate at our next meeting” in September, Powell said.
“That is a decision that will depend on the data we get between now and then,” he said.
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.
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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.
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.
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.”
“What we have right now doesn’t seem like that,” Powell said Wednesday after citing a similar definition. “There are too many areas of the economy performing too well.”
Powell pointed to strong job growth and low unemployment as two reasons why he does not believe the U.S. is currently in a recession — and he still hopes the Fed will be able to bring down inflation without triggering one.
How effective are the Fed’s actions?
The Fed’s monetary policies haven’t been fully felt across the economy, and more likely needs to be done, Powell said, referring to future rate hikes.
Still, overall economic growth has already been slowing, and the central bank said that “recent indicators of spending and production have softened.”
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.”
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