Fed Hikes Rates Again, Raising Risk of Recession To Bring Inflation Under Control

Article originally posted on CoStar on September 21, 2022

Central Bank Moves Aggressively After Price Increases Reach 40-Year High

Federal Reserve Board Chairman Jerome Powell looks at notes while speaking during a news conference after Wednesday's meeting of the Federal Open Market Committee. (Getty Images)
Federal Reserve Board Chairman Jerome Powell looks at notes while speaking during a news conference after Wednesday’s meeting of the Federal Open Market Committee. (Getty Images)

For the third time in as many meetings, the Federal Reserve’s policy-setting committee raised its target lending rate by three-quarters of a percentage point, the latest step in its aggressive campaign to battle decades-high inflation.

The unanimous decision on Wednesday to set the overnight lending target rate for banks to between 3.00% and 3.25% moves interest rates into what the Fed believes is restrictive territory that constrains economic growth, and increases the risks the country could tilt into recession.

The Fed signaled more hikes could come later in the year. Wednesday’s decision was the fifth rate increase in the Fed’s front-loaded tightening cycle, following the initial 25-basis-point hike at its March meeting, a 50-basis-point increase at its May meeting, and two hikes of 75 basis points at its June and July meetings.

The market had been largely expecting this increase as it was broadly transmitted by Fed governors in recent weeks. But the latest inflation report released last week revealed an acceleration of core inflation to 6.3% in August over the year, blindsiding most analysts who had expected inflation to have peaked in prior months and prompting Fed watchers to posit an even larger increase than was ultimately decided on at this meeting.

In his comments at the Fed’s policy retreat in Jackson Hole, Wyoming, last month, Fed Chairman Jerome Powell delivered the clear message that the central bank will not tolerate sustained elevated inflation and is willing to see economic activity stall in order to contain price increases. The Fed’s move Wednesday appears aimed at quelling fears that inflation is becoming entrenched.

In its issued statement, the committee began by noting that the economy remains steady although moderating. It blamed ongoing inflation on continuing supply and demand imbalances as well as the war in Europe. As for the outlook on its actions, the statement noted that “ongoing increases” are expected over coming months in order to return inflation to the Fed’s objective of 2%.

In addition to rate hikes, the bank is continuing to trim its balance sheet of Treasuries and mortgage-backed securities, a process that began in early June. Taken together, the tightening actions mark the Fed’s most aggressive stance in decades as it fights inflation that has reached a 40-year high.

At his post-meeting press conference, Powell promised that the committee will take “forceful and rapid steps” to cool the economy, which he expects will involve a sustained period of below-trend growth, until the committee sees “compelling evidence” that inflation is coming down to 2%.

In a separate note, the Fed released its updated Summary of Economic Projections, the forecasts of economic activity prepared by individual committee members. Compared to projections released in June, the median view of economic growth in 2022 was cut from 1.7% to 0.2%, and growth for 2023 to be 1.2%, a downgrade from the June projection of 1.7%. Inflation as measured by the core personal consumption expenditures price index is expected to be 5.4% in 2022, a continued acceleration over the June forecast of 5.2%, falling to 2.8% in 2023 and 2.3% in 2024. The median view of the unemployment rate in 2022 was lifted to 3.8% from 3.7%, increasing to 4.4% in 2024 as the economy slows.

Committee members expect the federal funds rate to reach 4.4% in 2022, suggesting another 125 basis points will be added to the policy rate by the end of the year. The committee has two more meetings planned in 2022. The remaining projections on the policy rate indicate ending 2023 at 4.6% before falling to 3.9% in 2024.

During his question-and-answer period, Powell noted that the chance of a navigating a soft landing will diminish if policy needs to be even more restrictive than expected or needs to be restrictive for longer if needed to see inflation come down meaningfully.