The Federal Reserve raised interest rates by three-quarters of a percentage point, the biggest enacted increase since 1994. It is the most aggressive move yet to rein in high inflation that squeezes the economy.
The Biggest Rate Increase Since 1994
Fed Chair, Jerome Powell, hinted during the press conference following the announcement that another big move is expected next month, maybe 75 or 50 bp hike. The board also raised its forecasts for interest rates to 3.4% this year and 3.8% by the end of 2023, much higher than 1.9% and 2.8% in March projections, the dot plot revealed.
“We thought that strong action was warranted at this meeting and we delivered on that,” Fed Chair Jerome Powell said in the post-meeting conference. “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.”
Meanwhile, Powell downplayed the risk of a series of super-sized rate increases stating that “Clearly, today’s 75 basis-point increase is an unusually large one and I do not expect moves of this size to be common,” adding that he expects to see a 50 or 75 basis points increase in July. He noted that the policy decisions will be made “meeting by meeting” and the Fed will “continue to communicate our intentions as clearly as we can.”
Weeks earlier, expectations were set for a 50 bp increase in interest rates, as in May. But the surprisingly outburst inflation report released last week and growing concerns that the Fed has lost its grip on prices indulged a more aggressive stance from policymakers to ease inflationary pressures.
One FOMC member, Esther L. George, voted to hike by only 50 bp this meeting.
The sharp hikes are likely to further slow the economy that hasn’t been fully recovered from the pandemic hit. Despite the robust labor market, 400,000 average monthly job gains in recent months, soaring inflation and higher interest rates seem to be major headwinds to the economy. Business investment rose less than expected in April, retail sales fell 0.3% in May and the housing market is dragged down by mortgage rates.
Fed Cuts Growth Outlook
The statement outlined a largely optimistic picture of the economy despite high inflation.
“Overall economic activity appears to have picked up after edging down in the first quarter. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.”FOMC Statement
However, the updated dot plot showed a significant cut in the 2022 economic growth outlook, now the committee anticipates GDP to grow by only 1.7% gain in GDP, down from 2.8% previously anticipated in March. For the next two years, GDP growth is seen at 1.7% and 1.9% down from 2.2% and 2% respectively.
Meanwhile, inflation gauged by personal consumption expenditures has revised to the upside from 4.3% to 5.2% this year. Though core inflation, which excludes volatile food and energy prices, is now seen at 4.3%, up by just 0.2% from the March projection. Hence, the projections suggest price pressures to ease in the coming months as PCE inflation printed a 4.9% increase in April.
US Dollar at 20-Year Highs
The US Dollar continued its prolonged upward with wider gains has been seen against major rivals. The US Dollar index (DXY) is trading around the 105.00 handle on Thursday, the highest in two decades. The EURUSD is down 0.40% at 1.0416 and the GBPUSD lost 0.27% trading near 1.2137. Meanwhile, the Japanese Yen was almost the only winner against the dollar, mainly due to its safe haven appeal, trading up 0.98% at 132.84.