The Federal Reserve lifted its benchmark interest rate by a quarter of a percentage point, the first increase since 2018 and the start of what US central bank officials signalled would be a series of hikes this year with further rises expected at all of the six remaining policy meetings.
At the end of its two-day policy meeting on Wednesday, the Federal Open Market Committee increased the federal funds rate by a quarter of a percentage point, bringing the target range to 0.25 to 0.50 per cent. It is the latest milestone for the US economy in its recovery from the pandemic and the most forceful step to date to combat the highest inflation in four decades.
In a press conference after the meeting, Jay Powell, Fed chair, said the committee had raised rates “against the backdrop of an extremely tight labour market in high inflation” and that it “anticipates that ongoing increases in the target range for the federal funds rate will be appropriate”.
The FOMC was not unanimous in its support of the quarter-point increase, however, with James Bullard, president of the St Louis Fed, dissenting in favour of a half-point rise.
Powell kept the door open to raising interest rates by increments larger than a quarter point this year, and said the committee is “acutely aware of the need to return the economy to price stability and determined to use our tools to do exactly that.”
Fed officials sharply revised higher their projections for interest rates this year compared to three months ago, when they had forecast three quarter-point rate rises in 2022, followed by five more in 2023 and 2024.
The so-called dot plot of individual interest rate projections of top officials now signals six more increases in 2022, in addition to the March move.
At least three increases have been pencilled in for 2023, bringing the fed funds rate to 2.8 per cent, above a “neutral” position that neither boosts nor constrains growth. A majority of Fed officials forecast a neutral rate of 2.4 per cent. No rate rises were forecast in 2024.
Underscoring the enormity of the hawkish shift that has taken place in just a matter of months, officials were evenly split on the need for an interest rate increase this year as recently as September.
Prices of US stocks and government bonds gyrated after the announcement. The yield on the benchmark 10-year Treasury note hit its highest level in almost three years shortly after the news, before falling back to 2.17 per cent. Bond yields fall when prices rise.
The S&P 500 briefly turned negative after the Fed’s announcement, before rallying strongly into the close to end up 2.2 per cent. The tech-heavy Nasdaq Composite advanced 3.8 per cent.
The Fed’s embrace of much tighter monetary policy comes despite a sharp escalation in tensions stemming from Russia’s invasion of Ukraine. The European Central Bank also adopted a more aggressive stance this month, scaling back its bond-buying plan as the war boosted inflation expectations.
Powell acknowledged the geopolitical uncertainty clouding the outlook, and emphasised that the conflict is likely to put “additional upward pressure on near-term inflation here at home and also weigh on economic activity”.
While the central bank has typically delayed making big policy decisions in periods of acute conflict to avoid exacerbating volatility, surging inflation and an extremely strong labour market have prompted the Fed to press ahead.
Fed officials on Wednesday also revised higher their forecasts for inflation, which is derived from the personal consumption expenditures price index. The median estimate for year-end core inflation, which strips out volatile items such as food and energy, rose to 4.1 per cent, from 2.7 per cent in December. Next year’s estimates also rose, with most officials now forecasting the core PCE index to hover at 2.6 per cent and 2.3 per cent in 2024. It currently stands at 5.2 per cent, well above the Fed’s 2 per cent target.
The decision showed “the Fed is quite concerned about inflation,” said Bob Michele, chief investment officer at JPMorgan Asset Management. “There is still a lot of reopening to come, and they need to get moving on normalising things.”
Brian Smedley, chief economist at Guggenheim Partners, said the Fed had “acknowledged the war in Ukraine . . . is putting more pressure on inflation”, adding: “They also acknowledged the broadening of price pressures, which necessitates a stronger policy response.”
The median estimate for US economic growth also moderated to 2.8 per cent from the 4 per cent pace projected in December, while the forecast for the unemployment rate held steady at 3.5 per cent. A majority of Fed officials expect the unemployment rate to rise to 3.6 per cent in 2024.
The Fed also hinted that a reduction in its enormous balance sheet will come soon — it more than doubled to $9tn over the course of the pandemic as the central bank hoovered up government bonds as part of its efforts to shore up the economy.
Powell said the committee is finalising its plans to begin reducing its holdings of Treasuries agency mortgage-backed securities and will announce further details at the May meeting.
Additional reporting by Eric Platt and Kate Duguid
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2022-03-16 20:56:03Z
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