Fed raises interest rates by largest amount since 1994 to fight inflation (2024)

For weeks, Fed leaders set expectations for an increase in interest rates of half a percentage point, as in May. But a surprisingly bleak inflation report released last week, the war in Ukraine and new growing signs that the markets and American public have lost faith in the Fed, ignited a more forceful push from central bank policymakers as they wrapped up two days of meetings.

“We thought that strong action was warranted at this meeting and we delivered on that,” Federal Reserve Chair Jerome H. Powell said in a news conference following the decision. “It is essential that we bring inflation down if we are to have a sustained period of strong labor market conditions that benefit all. … The current picture is plain to see: The labor market is extremely tight and inflation is much too high.”

The move to hike interest rates will make the price of mortgages, auto loans and a wide array of business investments more expensive. Rising interest rates work to cool off an overheated economy by dampening consumer spending, so that demand for goods and services falls, helping bring prices down. However, investors and some businesses are newly concerned that the move to get inflation under control could cool the economy too much, triggering a new recession and a wave of layoffs.

A ramped-up fight against rising prices could also usher in a wave of harsher consequences, including higher unemployment and reduced economic growth later this year, Fed leaders acknowledged.

“We don’t seek to put people out of work, of course. We never think too many people are working and fewer people need to have jobs,” Powell said. “But we also think you really cannot have the kind of labor market we want without price stability. We have to go back and establish price stability.”

In coming months, the Fed made clear that officials expect “ongoing increases” of three-quarters of a percentage point “will be appropriate,” although it is unclear exactly how many or how often. Kansas City Fed President Esther George voted against Wednesday’s rate hike decision, preferring a smaller rate hike of half a percentage point.

“Clearly today’s 75 basis point increase is an unusually large one and I do not expect moves of this size to be common,” Powell said, adding that he expects the Fed will raise rates another 50 to 75 basis points in July. “We will however make our decisions meeting by meeting.”

In May, prices climbed 8.6 percent compared with a year earlier, a new pandemic-era high. Soaring energy, housing and food prices continue to drive up costs at the fastest pace in 40 years, and Americans are feeling the strain in practically every part of their daily lives, from groceries to gas to rent.

Meanwhile, the markets fell this week as investors worried that the Fed was not up to the task of slashing inflation. On Monday, the S&P 500 tumbled nearly 4 percent to cross into a bear market — meaning the index has lost 20 percent of its value since its most recent peak. So far in 2022, losses have wiped out a hefty chunk of the stock market’s pandemic-era gains.

Financial markets closed higher Wednesday, after some volatility, with the tech-heavy Nasdaq up 2.5 percent and the Dow Jones industrial average gaining 1 percent.

The Fed is also fighting to regain the trust of American households and businesses worried that their costs of living will not go down anytime soon. Consumer sentiment in June sank to a low not seen since the 1980 recession, according to a University of Michigan survey released last week. Additionally, a poll by The Washington Post and George Mason University’s Schar School of Policy and Government found that most Americans expect inflation to worsen and are adjusting their spending habits, a mind-set that can make the surge in prices even worse.

Much of Powell’s message Wednesday was designed to rebuild that trust, experts say.

“A big part of the problem over the last year, maybe longer, has been that the Fed just doesn’t seem to be in control of the situation,” said Michael Strain, director of economic policy studies at the right-leaning American Enterprise Institute. “What we saw today suggests that they understand the seriousness of the situation, and therefore they’re willing to do what is required to address the situation.”

Rising prices are weighing heavily on President Biden’s approval ratings and hampering his economic message at a time when many Americans do not feel like the economy is working for them. Republicans are also poised to hammer Democrats on inflation going into the midterms later this year.

Fed officials are under pressure to lower inflation and slow the hiring without causing people to lose their jobs. But executing that plan will be exceedingly difficult. Indeed, a new crop of economic projections released at the end of Wednesday’s meeting pointed to a rising unemployment rate, lower economic growth and inflation that takes longer to fall.

The Fed expects the unemployment rate to tick up to 3.7 percent by the end of the year and get to 3.9 percent in 2023, as officials raise rates to slow hiring and consumer demand.

Powell said that even an unemployment rate that tips above 4 percent would reflect a healthy economy, especially if it was accompanied by more stable prices.

Fed officials also downgraded this year’s economic growth estimates to 1.7 percent.

The Fed also suggested higher interest rates would probably push inflation down to about 5.2 percent by the end of the year, higher than earlier estimates, using the Fed’s preferred gauge of measuring inflation.

The more dire projections leaned harder into the risk of a recession than policymakers have so far. Powell said the path to avoiding a recession “is not getting easier” and added that “many factors that we don’t control are going to play a very significant role in deciding whether that’s possible or not.”

“It was a very ominous set of projections,” said Skanda Amarnath, executive director of Employ America, a left-leaning think tank that advocates for the Fed to let the economy run hot. “On the other hand, Powell’s message was: ‘We’re going to stay adaptive. Put trust me. I’ll know when to stop … and I believe we can avoid a recession.’”

The repercussions of rising inflation are playing out globally. Policymakers from the European Central Bank held a rare unscheduled meeting Wednesday to address higher borrowing costs for many European governments and address fears of a debt crisis.

Now, the Fed faces the enormous task of squashing inflation without damaging the rest of the economy, which has been booming, especially for workers. The Fed’s leaders have said they hope that interest rate hikes will slow demand for workers and help get the labor market — which has about two job openings for each person looking for work — back on a more sustainable path.

But the Fed cannot slow the economy with much precision. If policymakers move too abruptly, they can trigger a sudden economic downturn, risking job losses and sending the country into recession.

“There’s always a risk of going too far or going not far enough,” Powell said. “It’s going to be a difficult judgment to make, or maybe not. Maybe it will be quite clear.”

On top of it all, it’s unclear whether a steady stream of Fed rate hikes will be a match for the kind of inflation dogging the post-pandemic economy.

One big driver of inflation is energy and gas prices, which surged since Russia’s February invasion of Ukraine. Supply chain issues continue to push up prices for cars and construction materials. Ultimately, rate hikes can’t address semiconductor shortages or end a war, nor can they assuage peoples’ anxiety about paying a national average of $5 per gallon at the gas pump.