Fed hikes interest rates to fight record inflation

The Federal Reserve on Wednesday increased its baseline interest rate range, launching the first in what will likely be a series of rate hikes meant to fight inflation.

The Federal Open Market Committee (FOMC), the panel of Fed officials responsible for setting monetary policy, increased the federal funds rate by 0.25 percentage points to a range of 0.25 to 0.5 percent. The federal funds rate is the benchmark interest rate banks charge on loans to each other and is used to set borrowing costs on credit cards, automobile loans and mortgages.

“The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The implications for the U.S. 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,” the FOMC said in a statement.

“In support of these goals, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent and anticipates that ongoing increases in the target range will be appropriate.”

Eight of the FOMC’s nine voting members supported the decision to hike rates. The sole dissenter was James Bullard, president of Federal Reserve of St. Louis, who preferred a 0.5 percentage point hike.

The FOMC also projected roughly six more rate hikes this year, along with slower growth and higher inflation.

The panel’s median estimate of the year-end unemployment rate held at 3.5 percent, in line with their December projections and equal to February 2020 jobless rate. But the FOMC’s median estimate of gross domestic product (GDP) growth fell from 4 percent to 2.8, while the year-end annual inflation rate they projected rose from 2.6 percent to 4.3 as measured by the personal consumption expenditures price index.

Fed Chairman Jerome Powell expressed confidence the U.S. economy would hold strong as the bank boosted borrowing costs. He said while growth was on track to slow from the 5.8 percent increase in GDP last year, the Fed’s projection is “still quite strong.”

Fed officials signaled for months that they would hike rates and begin pulling back stimulative interest rates in March after two years of rapid economic growth and high inflation.

The hike comes almost exactly two years after the Fed slashed rates to near-zero levels and began buying billions of dollars of Treasury bonds and mortgage-backed securities each month to stimulate the economy through the COVID-19 recession.

The U.S. economy has since recovered all but 2.1 million of the more than 20 million jobs lost during the onset of the pandemic, grew by 5.8 percent in 2021 and powered consumer spending well above pre-pandemic levels.

Economists credit unprecedented stimulus from both the Fed and Congress along with the quick development of effective COVID-19 vaccines for the swift recovery of the U.S. economy.

Even so, the economy’s rapid rebound came with a spike in consumer prices. As vaccines and stimulus powered a surge in consumer demand, pandemic-driven supply constraints, labor shortages, manufacturing backlogs, shipping bottlenecks and shutdowns abroad pushed prices higher.

Annual inflation as measured by the personal consumption expenditures price index, the Fed’s preferred gauge, hit 6.1 percent in January — three times the Fed’s annual average target of 2 percent.

While high inflation was limited to a few sectors hit hard by specific supply shortages earlier in 2021, prices for food, energy, shelter and a wide range of services have begun to increase at faster rates in recent months. Powell has called high inflation the biggest threat to an otherwise strong economy and previously acknowledged to members of Congress the bank had misjudged how long it would last.

The war in Ukraine and recent COVID-19 outbreaks in China are also likely to fuel more price increases for food and energy.

Powell said Wednesday he initially expected inflation to peak around the first quarter of the year before starting to fade in the second half. The Fed chief now expects inflation to continue rising, predominately through higher oil prices, before rate hikes begin to have an effect on price growth.

Higher interest rates are likely to slow consumer spending and give businesses less room to boost wages. Powell said the demand for labor has risen to an “unhealthy” level, citing the nearly 2-to-1 ratio of job openings to unemployed workers.

Some economists have expressed concerns the Fed could now be forced to hike rates high enough to seriously slow the economy in order to curb inflation. The Fed had faced pressure for months from some lawmakers, investors and policymakers to hike far sooner than it did over concerns over a future inflation-driven recession.

But Powell expressed confidence in the Fed’s ability to bring prices down without tanking the economy.

“All signs are that this is a strong economy, indeed, one that will be able to flourish — not to say withstand, but certainly flourish, as well — in the face of less accommodative monetary policy,” Powell said in a press conference following the announcement.

“We do feel the economy is very strong, and well positioned to withstand tighter monetary policy.”

Updated at 3:22 p.m.