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US Begins Inflation Fight With Key Rate Hike; More to Come


A television screen on the floor of the New York Stock Exchange, March 16, 2022, shows the rate decision of the Federal Reserve.

The U.S. Federal Reserve launched a high-risk effort Wednesday to tame the worst inflation since the early 1980s, raising its benchmark short-term interest rate and signaling up to six additional rate increases this year.

The Fed's quarter-point hike in its key rate, which had been pinned near zero since the pandemic recession struck two years ago, marks the start of its effort to curb the high inflation that followed the recovery from the recession. The rate hikes will eventually mean higher loan rates for many consumers and businesses.

The central bank, in a policy statement, along with quarterly projections and remarks by Chair Jerome Powell at a news conference, pointed to a somewhat more aggressive approach to rate hikes than many analysts had expected.

U.S. Federal Reserve Board Chairman Jerome Powell testifies during his re-nomination hearing before a Senate Committee, on Capitol Hill in Washington, Jan. 11, 2022.
U.S. Federal Reserve Board Chairman Jerome Powell testifies during his re-nomination hearing before a Senate Committee, on Capitol Hill in Washington, Jan. 11, 2022.

The projections showed that seven of the central bank's 16 policymakers favor at least one half-point rate hike this year, suggesting that such a large increase is possible, said Michael Feroli, an economist at JPMorgan Chase.

At his news conference, Powell stressed his confidence that the economy is strong enough to withstand higher interest rates. But he also made clear that the Fed is focused on doing whatever it takes to reduce inflation, over time, to its 2% annual target. Otherwise, Powell warned, the economy might not sustain its recovery from the pandemic recession.

"We're acutely aware of the need to restore price stability," the Fed chair said. "In fact, it's a precondition for achieving the kind of labor market that we want. You can't have maximum employment for any sustained period without price stability."

Quarterly projections

The Fed also released a set of quarterly economic projections Wednesday that underscored the potential for extended interest rate increases in the months ahead. Seven hikes would raise its short-term rate to between 1.75% and 2% at the end of 2022. Fed officials also forecast four more rate increases in 2023, which would boost its benchmark rate to 2.8%.

That would be the highest level since March 2008. Borrowing costs for mortgage loans, credit cards and auto loans will likely rise as a result.

"Clearly, inflation has moved front and center into the Fed's thinking," said Tim Duy, chief U.S. economist at SGH Macro Advisors.

The central bank's policymakers expect inflation to remain elevated, ending 2022 at 4.3%, according to quarterly projections they released Wednesday. The officials also forecast a much slower economic growth of 2.8% this year, down from a 4% estimate in December.

But many economists worry that with inflation already so high — it reached 7.9% in February, the worst in four decades — and with Russia's invasion of Ukraine driving up gas prices, the Fed may have to raise rates even higher than it now expects and potentially cause a recession.

By its own admission, the central bank underestimated the breadth and persistence of high inflation after the pandemic struck. And many economists say the Fed has made its task riskier by waiting too long to begin raising rates.

The Fed's projections show that by the end of next year, the policymakers expect their short-term rate to be above "neutral" — the level at which they think the rate neither fuels nor slows economic growth.

Roberto Perli, an economist at Piper Sandler, questioned Powell's assurances that the economy could withstand such higher rates.

"In the past, whenever the Fed has approached — let alone exceeded — neutral, the economy weakened sharply," Perli wrote in a note to clients. "The risk of recession in 2023 and beyond is increasing."

Powell's predictions

Yet Powell downplayed the likelihood of an economic setback.

"The probability of a recession in the next year is not particularly elevated," he said.

At his news conference, Powell said he believed that inflation would slow later this year as supply chain bottlenecks clear and more Americans return to the job market, easing upward pressure on wages.

He also suggested that over time, the Fed's higher rates will reduce consumer spending on interest rate-sensitive items such as autos and cars. Americans may also buy less as credit card rates increase. Those trends would eventually reduce businesses' demand for workers and slow pay raises, which are running at a robust 6% annual rate, and ease inflation pressures.

Powell noted that there are a near-record number of job openings, leaving 1.7 available jobs, on average, for every unemployed person. As a result, he expressed confidence that the Fed can lower demand for workers and wage growth without increasing unemployment.

"All signs are that this is a strong economy," he said, "one that will be able to flourish in the face of less accommodative monetary policy."

The Fed's forecast for numerous additional rate hikes in the coming months initially disrupted a strong rally on Wall Street, weakening stock gains and sending bond yields up. But stock prices more than recovered their gains soon after the press conference began.

Most economists say that sharply higher rates are long overdue to combat the escalation of inflation across the economy.

"With the unemployment rate below 4%, inflation nearing 8%, and the war in Ukraine likely to put even more upward pressure on prices, this is what the Fed needs to do to bring inflation under control," said Mike Fratantoni, chief economist at the Mortgage Bankers Association.

Powell is steering the Fed into a sharp U-turn. Officials had kept rates ultra-low to support growth and hiring during the recession and its aftermath. As recently as December, Fed officials had expected to raise rates just three times this year.

One member of the Fed's rate-setting committee, James Bullard, head of the Federal Reserve Bank of St. Louis, dissented from Wednesday's decision. Bullard favored a half-point rate hike, a position he has advocated in interviews and speeches.

The Fed also said it would begin to reduce its nearly $9 trillion balance sheet, which has more than doubled in size during the pandemic, "at a coming meeting." That step will also have the effect of tightening credit for many consumers and businesses.

Since its last meeting in January, the challenges and uncertainties for the Fed have escalated. Russia's invasion has magnified the cost of oil, gas, wheat and other commodities. China has closed ports and factories again to contain a new outbreak of COVID-19, which will worsen supply chain disruptions and likely further fuel price pressures.

In the meantime, the sharp rise in average gas prices since the invasion, up more than 60 cents to $4.31 a gallon nationally, will send inflation higher while also probably slowing growth — two conflicting trends that are notoriously difficult for the Fed to manage simultaneously.

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