The Federal Reserve approved its largest interest rate hike in more than a quarter-century on Wednesday to stem a surge in inflation that U.S. central bank officials acknowledged may be eroding public trust in their power and is being driven by events that appear to be increasingly beyond their control.

The widely anticipated action increased the target federal funds rate by three-quarters of a percentage point to a range of 1.5 per cent to 1.75 per cent, which is still low by historical standards.

However, the Fed’s aggressive commitment to managing inflation has already triggered a broad tightening of lending conditions, which is being felt in the US housing and stock markets, and is likely to reduce demand throughout the economy – the Fed’s intention.

Officials also anticipate consistent rate increases through the remainder of the year, possibly including additional 75-basis-point increases, with a federal funds rate of 3.4 percent by the end of the year. That would be the largest level since January 2008, and enough, according to Fed predictions, to significantly slow the economy in the coming months and lead to an increase in unemployment.

“We don’t seek to put people out of work,” Fed Chair Jerome Powell said at a news conference after the end of the Fed’s latest two-day policy meeting, adding that the central bank was “not trying to induce a recession.”

Nonetheless, the Fed chairman’s remarks were among his most sobering yet about the challenge he and his colleagues face in lowering inflation from its current 40-year high to a level closer to its 2 per cent target without causing a sharp slowdown in economic growth or a sharp increase in unemployment.

“Our objective really is to bring inflation down to 2% while the labor market remains strong … What’s becoming more clear is that many factors that we don’t control are going to play a very significant role in deciding whether that’s possible or not” Powell said, citing the war in Ukraine and global supply concerns.

“There is a path for us to get there … It is not getting easier. It is getting more challenging,” he told reporters, noting that the rate hikes announced last month and in March so far had not only failed to slow inflation, but allowed it to continue accelerating to a level that recent data indicates have begun to influence public attitudes in a way that could make the Fed’s job even harder.

Consumer inflation expectations rose sharply in June, according to a survey released on Friday, a result Powell called “quite eye-catching” and enough to sway policymakers toward a larger 75-basis-point hike in the hopes of making faster progress on inflation and retaining public trust that price increases will slow.

“This is something we need to take seriously,” Powell said of the change in consumer inflation expectations. “We’re absolutely determined to keep them anchored.”

The faster pace of rate hikes detailed by officials on Wednesday more closely aligns monetary policy with the abrupt shift in financial market perceptions of what it will take to keep price pressures under control that occurred this week.

Bond yields fell on Wednesday with the release of Fed estimates showing economic growth dropping to a below-trend rate of 1.7 per cent and policymakers planning to decrease interest rates in 2024. Wall Street stocks finished the day higher.

Interest rate futures markets also indicated that the Fed is likely to hike rates by 75 basis points at its next policy meeting in July. However, the higher possibility – at more than 50% – was for a 50-basis-point hike at the September meeting.

Powell made no assurances on Wednesday, breaking from the firmer advice he had previously provided about future rate hikes.

Given the surprise increase in the monthly inflation report on Friday, as well as the increase in expectations, “75 basis points looked like the proper thing to do at this meeting, and that’s what we did,” he said.

However, he stated that such rate increases were unlikely to be “frequent,” and that when Fed policymakers meet in July, an increase of half a percentage point or three-quarters of a percentage point would be “most likely.”

(Adapted from Investing.com)

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