The Federal Reserve is likely to approve a historic, full percentage point interest rate hike when officials meet next week following the hotter-than-expected August inflation data, according to analysts at Nomura Holdings.
"Materializing upside inflation risks are likely to result in the Fed raising rates by 100bp at the September FOMC meeting, above our previous forecast of 75bp," Nomura said in an analyst note.
That would be the first rate hike of its size since the Fed started announcing moves in the overnight federal funds rate in 1994 and would put the benchmark range between 3.25% and 3.50%, the highest since the 2008 financial crisis.
Investors lifted their expectations of a mega-sized rate hike following the Labor Department report released Tuesday, which showed the consumer price index rose 8.3% in August from a year ago and 0.1% on a monthly basis, dashing investor hopes for an inflation slowdown.
Even more concerning is that so-called core prices, which strip out the more volatile measurements of food and energy, re-accelerated last month: Core prices climbed 6.3% from the previous year, above the 6.1% forecast from economists, and climbed 0.6% on a monthly basis – a bigger increase than in April, May, June and July, and a troubling sign that underlying inflationary pressures in the economy remain strong.
Wall Street is now penciling in a 28% chance of a super-sized rate hike at the Fed's Sept. 20-21 meeting, according to the CME Group's FedWatch tool, which tracks trading.
Federal Reserve Chairman Jerome Powell declined to rule out a 100-basis-point interest rate hike at the central bank's July meeting, during which officials voted to lift rates by 75 basis points for the second consecutive month. Powell signaled that another three-quarter percentage point increase could be on the table, but that the decision ultimately hinged on the forthcoming economic data.
But that was before the August inflation report, which experts agree was resoundingly bad, underscoring just how strong inflationary pressures in the economy still are. Bond yields spiked higher and stocks tumbled after the worse-than-expected report fueled fears that the Fed will have to ratchet up its inflation battle.
The Fed is in a precarious situation as it walks the line between cooling consumer demand and bringing inflation closer to its 2% target without inadvertently dragging the economy into a recession. Hiking rates tends to create higher rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending.
Powell has acknowledged the risk of a recession but maintained that it's more important for the Fed to tame inflation, even if an economic downturn ensues.
"While higher interest rates, slower growth and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses," he said last month while speaking in Jackson Hole, Wyoming. "These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain."