US Fed makes first interest rate hike since 2018 and sees 6 more this year

The Federal Reserve Board building is seen in Washington, DC, on March 16, 2022. PHOTO: AFP

NEW YORK (BLOOMBERG) - The Federal Reserve raised interest rates by a quarter percentage point and signalled hikes at all six remaining meetings this year, launching an aggressive campaign to tackle the fastest inflation in four decades even as risks to economic growth mount.

Policymakers led by chairman Jerome Powell voted 8-1 to lift their key rate to a target range of 0.25 per cent to 0.5 per cent, the first increase since 2018, after two years of holding borrowing costs near zero to insulate the economy from the coronavirus pandemic. St Louis Fed president James Bullard dissented in favour of a half-point hike, the first vote against a decision since September 2020.

“The American economy is very strong and well positioned to handle tighter monetary policy,” Mr Powell told a press conference on Wednesday (March 16) following a meeting of the Federal Open Market Committee (FOMC). “I saw a committee that is acutely aware of the need to return the economy to price stability.”

The S&P 500 index briefly erased its gains on the decision before rebounding after Mr Powell played down the risk of a recession and declared the economy strong enough to withstand tighter policy. It closed over 2 per cent higher.

“This is going to be a pretty aggressive tightening cycle, I don’t know if the Fed is going to pull off a soft landing,” said Mr Ryan Sweet, head of monetary policy research at Moody’s Analytics. “It’s very clear the Fed is more than doubling down on addressing inflation.”

The hike is likely the first of several to come this year, as the Fed said it “anticipates that ongoing increases in the target range will be appropriate”, and Mr Powell repeated his pledge to be “nimble.”

In the Fed’s so-called dot plot, officials’ median projection was for the benchmark rate to end this year at about 1.9 per cent – in line with traders’ bets but higher than previously anticipated – and then rise to about 2.8 per cent next year. They estimated a 2.8 per cent rate in 2024, the final year of the forecasts, which are subject to even more uncertainty than usual given Russia’s invasion of Ukraine and new Covid-19 lockdowns in China are buffeting the global economy.

“The invasion of Ukraine by Russia is causing tremendous human and economic hardship,” the FOMC said in its policy statement following the two-day meeting in Washington, the first held in person – rather than via videoconference – since the pandemic began.

“The implications for the US economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.

“FOMC participants have backed up chairman Powell’s hawkish words. They are serious about controlling inflation, and are willing to hike rates faster and higher than previously expected.”

 The Fed said it would begin allowing its US$8.9 trillion (S$12 trillion) balance sheet to shrink at a “coming meeting” without elaborating. Mr Powell said officials had made good progress this week in nailing down their plans and could be in a position to begin the process at their May meeting, though the FOMC had not taken a decision to do so.

The purchases of Treasuries and mortgage-backed securities, which concluded this month, were intended to provide support to the economy during the Covid-19 crisis and shrinking the balance sheet accelerates the removal of that aid.

The statement omitted previous language saying that the economy’s path depended on the course of the coronavirus, though it kept a reference to the pandemic’s impact on inflation.

The Fed faces the arduous task of securing a soft landing for the world’s largest economy, a very rare outcome. Tighten too slowly and it risks allowing inflation to run out of control, requiring even tougher action. Shift too quickly and the central bank could roil markets and tip the economy into recession.

Complicating the job: The war has sent the cost of fuel, food and metals racing even higher, raising fears of 1970s-style stagflation by posing threats to prices, growth and financial-market stability.

In new economic projections, Fed officials said they see inflation significantly higher than previously anticipated, at 4.3 per cent this year, but still coming down to 2.3 per cent in 2024. The forecast for economic growth this year was lowered to 2.8 per cent from 4 per cent, while unemployment projections were little changed.

The pivot to tighter monetary policy is sharper than policymakers expected just three months ago, when their median projection was for just three quarter-point rate increases this year.

Forcing the pace is a surge in inflation which has proved stronger and more sustained than anticipated. The consumer price index soared 7.9 per cent last month, the most since 1982; the Fed’s 2 per cent inflation target is based on a separate gauge, the personal consumption expenditures price index, which rose 6.1 per cent in the 12 months through January.

The Fed previously held off from raising rates as officials bet the inflation shock would fade once the economy returned to normal following the pandemic recession and lockdowns, though they were also cautious amid new Covid-19 variants and data showing a choppy jobs recovery.

Instead, price gains accelerated amid a mixture of massive government stimulus, tightening labour markets, surging commodity costs and frayed supply chains. Mr Powell has also been operating under a Fed policy framework, adopted in mid-2020, to allow some above-target inflation in the hope of broadening employment.

Critics say the Fed was too slow in changing course and is now behind the curve in taking on price gains that could become more entrenched if companies pass on elevated costs to consumers who react by demanding higher wages.

At the same time, the worsening inflation picture has handed Mr Powell political cover to hike rates as he awaits Senate confirmation for a second term. American households and businesses have reacted with alarm to rising costs, with retail petrol surpassing US$4 a gallon, though it could fall following the latest drop in crude oil.

Top priority

US President Joe Biden has called taming inflation his top economic priority, while fellow Democrats worry failure to restrain prices could cost them their thin congressional majorities in November’s mid-term elections.

Mr Powell also bucked some calls for a larger half-point increase, which would have been the first since 2000. Some on Wall Street predict it could deliver such a salvo in coming months if inflation does not retreat.

On the positive side, American households are in a strong position, with the unemployment rate at 3.8 per cent and savings having risen throughout the pandemic.

Bloomberg Economics predicts the Fed could end up lifting rates to as high as 3.25 per cent some time next year, which would be the highest since 2008. Policymakers now see their longer-run federal funds rate at 2.4 per cent versus 2.5 per cent in the December forecast.

The Fed is not alone in turning more hawkish. The European Central Bank last week made a surprise announcement that it would be more aggressive in paring back bond-buying. The Bank of England is also set to lift rates on Thursday for a third straight meeting, while Brazil’s central bank is predicted to hike by another 100 basis points on Wednesday.

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