The Federal Reserve is raising its benchmark interest rate by a quarter of a percentage point, central bank officials said on Wednesday, the eighth straight increase as policymakers try to curb inflation.
The latest increase in the federal funds rate — what banks charge each other for short-term loans — was less than 0.5 percentage point the Fed increase in December as well as a three-quarter point streak moving into 2022.
With the latest increase, the Fed’s target rate is set at a range between 4.50% and 4.75%, its highest level since late 2007.
The Federal Reserve said its campaign to contain prices is working, while indicating it plans to keep interest rates high for some time.
“Over the past year, we have taken decisive action to tighten the stance of monetary policy,” Fed Chairman Jerome Powell said at a press conference on Wednesday. “However, we still have work to do. Price stability is the responsibility of the Federal Reserve and serves as the foundation of our economy,” he said.
“We expect the current hikes to be appropriate,” Powell added.
The move to ease the pace of monetary tightening, which economists and investors had expected, comes amid signs that the U.S. economy is cooling and concerns for a possible recession later this year.
The Federal Reserve is rapidly raising interest rates from March 2022 in an attempt to quell persistent inflation. High interest rates slow the economy by making it more expensive for consumers and companies to borrow money. But policymakers worry that raising interest rates too high could tip the economy into recession.
Although Powell emphasized his commitment to contain inflation, the battle may be entering a different phase aimed at soft landing the economy. The Fed hinted at the “magnitude” of any future rate hikes, in contrast to the wording in its December statement about the “pace” of tightening.
The change in language, while nuanced, suggests the Fed will now use smaller rate hikes to tame inflation, according to analysts at Morgan Stanley.
U.S. inflation fell from an annual rate of 9.1 percent this summer — the highest level in four decades — to a more modest 6.5% in December. The Fed has signaled it wants inflation to fall closer to its 2% target before easing the pace of monetary tightening.
Labor market “out of balance”
Despite cooling inflation and slowing economic growth, Powell said the labor market remains too strong to push prices and wages down to what the Fed considers healthy.
“The labor market remains extremely tight, with the unemployment rate at a 50-year low, job vacancies very high and wage growth strong,” he said, adding that “the labor market remains out of balance.”
The central bank fears that if workers are able to switch jobs too easily and demand higher pay, it could prompt corporations to raise prices even further, perpetuating inflation.
“Reducing inflation will likely require a period of below-trend growth and softening labor market conditions,” he added.
When will interest rates fall?
Investors generally expect the Fed to hold off on raising interest rates as the economy slows. Most analysts expect just one more rate hike to the upper 5% range, and many believe the Fed will actually cut rates this year as the economy enters a mild recession.
However, Powell played down those expectations. If the economy performs in line with the Fed’s expectations of “slower growth, some easing in labor market conditions and inflation moving down steadily but not rapidly … it would not be appropriate to cut rates this year “, he said.
Powell acknowledged that with commodity prices falling, “the process of disinflation has begun,” a comment that sent shares soaring. However, he cautioned against stopping interest rate hikes too early. Falling goods account for less than half of overall inflation, and the Fed wants hard evidence of lower prices in the housing and other services sectors before ending the rate-hike cycle.
“In this situation where we still have the highest inflation in 40 years, the job is not quite done,” Powell said. “It would be very premature to declare victory or to think that we have really achieved this.”