Fed to implement second 0.75 point rate rise amid uncertainty over next steps

Fed to implement second 0.75 point rate rise amid uncertainty over next steps

The Federal Reserve is poised to take another dramatic step this week to curb alarmingly high inflation, but the US central bank’s strategy beyond that point is less certain as it weighs a fresh peak in consumer price growth against mounting recession risks.

The Federal Open Market Committee on Wednesday is set to confirm market expectations and raise its benchmark policy rate by 0.75 percentage points for the second consecutive month. That will hoist the federal funds rate to a target range of 2.25 per cent to 2.50 per cent, in line with officials’ long-term estimates of a “neutral” policy setting.

A series of interest rate rises is planned beyond July, but with nascent signs of consumer distress emerging and tentative forecasts that the worst of the recent inflation shocks have passed, the Fed faces an increasingly difficult task of deciding how to recalibrate its path forward.

“What they’ve been doing over the last few months is really trying to grab back control of the narrative, because they’ve taken a huge amount of flak for being too slow to start raising rates and too slow to recognise the strength of the economy,” said Ian Shepherdson, chief economist at Pantheon Economics. “But if they keep banging away with [0.75 percentage point rate rises] into the fall, I’d get really worried that that would be overkill.”

Wednesday’s decision marks the next phase of the Fed’s campaign to “front-load” its monetary tightening and “expeditiously” get interest rates to a level that no longer stimulates growth, having already broken precedent and moved well beyond the quarter-point adjustments typical of past hiking cycles.

At one point following the release of alarming inflation data this month, market participants ratcheted up bets that the central bank would even raise rates by a full percentage point. However those odds dropped days later as Fed officials signalled their preference for another 0.75 percentage point adjustment for the meeting.

The central bank’s decision to aggressively raise rates in quick succession stemmed from what it deemed was an urgent need to cool down the economy and ensure that expectations of future inflation remain in check.

Despite inflation reaching new heights, the red-hot housing market has cooled dramatically, business activity across the country has slowed and several high-profile companies have shelved hiring plans or announced lay-offs.

Many economists now forecast a recession in the next six to 12 months, with momentum in the labour market ebbing and eventually leading to job losses that will push the unemployment rate closer to 5 per cent, according to some estimates. It currently stands at 3.6 per cent.

Notably, no policymaker has yet pencilled in an economic contraction, but many officials — including Fed chair Jay Powell — have conceded that the path to achieving a “soft landing” has narrowed considerably.

“The risks surrounding the economic outlook are becoming more two-sided in my view, but the Fed’s policy rhetoric is still fairly one-sided in terms of its focus on inflation,” said Brian Sack, director of global economics for the DE Shaw group and a former senior Fed official.

“The Fed’s hawkish policy message and aggressive rate changes to date have been productive, but I anticipate the need to move to a more balanced policy message and a slower pace of tightening later this year,” he added.

After this month’s gathering, the Fed next convenes for a policy meeting in September, when policymakers are expected to either raise rates by another 0.75 percentage points or downshift to a half-point adjustment. By the end of the year, the fed funds rate is projected to surpass 3.5 per cent at the very least.

How quickly the Fed gets there will depend on the data. Oil and other commodity prices have dropped from recent highs, which will help to ease some of the upward pressure on headline inflation figures. But a rise in rents and other services-related costs threaten to offset this, heaping pressure on the central bank to not ease up on its tightening programme.

“They have taken full responsibility for inflation, and yet the inflation that they’re trying to bring down with monetary policy tools has causes that are not monetary in nature,” said Dennis Lockhart, former president of the Atlanta Fed. “When you’re in that situation, you might be tempted to try harder.”

Lockhart warns there is now a greater risk that the Fed goes on “too long” and does “too much”.

With a recession now “probable” and consumers beginning to feel the pinch of higher borrowing costs, according to Diane Swonk, chief economist at KPMG, the Fed’s job is set to become much more challenging.

“It’s one thing to feel the pain of inflation,” she said. “But then you add on top of that that inflation is going to come down, but not in the way that it doesn’t distort [people’s] lives, at the same time that unemployment is going up. That’s when it gets really hard.”

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