Intensifying its fight against chronically high inflation, the Federal Reserve raised its key interest rate Wednesday by a substantial three-quarters of a point for a third straight time, an aggressive pace that is heightening the risk of an eventual recession.
The Fed’s move boosted its benchmark short-term rate, which affects many consumer and business loans, to a range of 3% to 3.25%, the highest level since early 2008. The policymakers also signaled that by early 2023, they expect to have further raised rates much higher than they had projected in June.
The central bank's action followed a government report last week that showed high costs spreading more broadly through the economy, with price spikes for rents and other services worsening even though some previous drivers of inflation, such as gas prices, have eased. By raising borrowing rates, the Fed makes it costlier to take out a mortgage or an auto or business loan. Consumers and businesses then presumably borrow and spend less, cooling the economy and slowing inflation.
Fed officials have said they’re seeking a “soft landing,” by which they would manage to slow growth enough to tame inflation but not so much as to trigger a recession. Yet economists increasingly say they think the Fed’s steep rate hikes will lead, over time, to job cuts, rising unemployment and a full-blown recession late this year or early next year.
Chair Jerome Powell acknowledged in a speech last month that the Fed’s moves will “bring some pain” to households and businesses. And he added that the central bank’s commitment to bringing inflation back down to its 2% target was “unconditional.”
Falling gas prices have slightly lowered headline inflation, which was a still-painful 8.3% in August compared with a year earlier. Declining gas prices might have contributed to a recent rise in President Joe Biden’s public approval ratings, which Democrats hope will boost their prospects in the November midterm elections.
The economy hasn't seen rates as high as the Fed is projecting since before the 2008 financial crisis. Last week, the average fixed mortgage rate topped 6%, its highest point in 14 years. Credit card borrowing costs have reached their highest level since 1996, according to Bankrate.com.
Powell and other Fed officials still say the Fed's goal is to achieve a “soft landing," by which they would slow the economy enough to tame inflation but not so much as to trigger a recession.
By last week, though, that goal appeared further out of reach after the government reported that inflation over the past year was a painful 8.3%. Even worse, so-called core prices, which exclude volatile food and energy costs, rose much faster than expected.
The inflation report also documented just how broadly inflation has spread through the economy, complicating the the Fed's task. Inflation now appears increasingly fueled by higher wages and by consumers' steady desire to spend and less by the supply shortages that had bedeviled the economy during the pandemic recession.
“They’re going try to avoid recession,” said William Dudley, formerly the president of the Federal Reserve Bank of New York. “The problem is that the room to do that is virtually non-existent at this point.”
The Fed’s rapid rate hikes mirror steps that other major central banks are taking, contributing to concerns about a potential global recession. The European Central Bank last week raised its benchmark rate by three-quarters of a percentage point. The Bank of England, the Reserve Bank of Australia and the Bank of Canada have all carried out hefty rate increases in recent weeks.
And in China, the world’s second-largest economy, growth is already suffering from the government’s repeated COVID lockdowns. If recession sweeps through most large economies, that could derail the U.S. economy, too.
At his news conference Wednesday, Powell isn't likely to drop any hints that the central bank will ease up on its credit tightening campaign. Most economists expect the Fed to stop raising rates in early 2023. But for now, they expect Powell to reinforce his hard-line anti-inflation stance.
“It's going to end up being a hard landing,” said Kathy Bostjancic, an economist at Oxford Economics.
“He’s not going to say that," Bostjancic said. But, referring to the most recent Fed meeting in July, when Powell raised hopes for an eventual pullback on rate hikes, she added: "He also wants to make sure that the markets don’t come away and rally. That’s what happened last time.”
Indeed, investors responded then by bidding up stock prices and buying bonds, which lowered rates on securities like the benchmark the 10-year Treasury. Higher stock prices and lower bond yields generally boost the economy — the opposite of what the Fed wants.
The central bank has already engaged in the fastest series of rate hikes since the early 1980s. Yet some economists — and some Fed officials — argue that they have yet to raise rates to a level that would actually restrict borrowing and spending and slow growth.
Loretta Mester, president of the Cleveland Federal Reserve Bank, and one of the 12 officials who will vote on the Fed's decision Wednesday, said she thinks it will be necessary to raise the Fed's rate to “somewhat above 4% by early next year and hold it there."
“I do not anticipate the Fed cutting” rates next year, Mester added, dispelling the expectations of many investors on Wall Street who had hoped for such a reversal. Comments like Mester's contributed to a sharp fall in stock prices last month that began after Powell's stern anti-inflation speech at the conference in Jackson Hole.
“Our responsibility to deliver price stability is unconditional,” Powell said then — a remark widely interpreted to mean that the Fed will fight inflation even if it requires deep job losses and a recession.
Many economists sound convinced that a recession and widespread layoffs will be necessary to slow rising prices. Research published earlier this month under the auspices of the Brookings Institution concluded that unemployment might have to go as high as 7.5% to get inflation back to the Fed's 2% target.
Only a downturn that harsh would reduce wage growth and consumer spending enough to cool inflation, according to the a paper by Johns Hopkins University economist Laurence Ball and two economists at the International Monetary Fund.