The Federal Reserve lifted its benchmark interest rate by a quarter of a percentage point, the first increase since 2018 and the start of what US central bank officials signalled would be a series of hikes this year with further rises expected at all of the six remaining policy meetings.
At the end of its two-day policy meeting on Wednesday, the Federal Open Market Committee increased the federal funds rate by a quarter of a percentage point, bringing the target range to 0.25 to 0.50 per cent. It is the latest milestone for the US economy in its recovery from the pandemic and the most forceful step to date to combat the highest inflation in four decades.
The FOMC was not unanimous in its support of the quarter-point increase, however, with James Bullard, president of the St Louis Fed and a voting member on the committee this year, dissenting in favor of a larger half-point rise.
Powell has previously said raising interest rates by increments larger than a quarter point is possible at one or more meetings this year.
Fed officials sharply revised higher their projections for interest rates this year compared to three months ago, when they had forecast three quarter-point rate rises in 2022, followed by five more in 2023 and 2024.
According to the so-called dot plot of individual committee members’ interest rate projections, policymakers now expect six more interest rate increases in 2022, in addition to the March move.
At least three increases have been pencilled in for 2023, bringing the fed funds rate to 2.8 per cent, above a “neutral” position that neither boosts nor constrains growth. A majority of Fed officials forecast a neutral rate of 2.4 per cent. No rate rises were forecast in 2024.
Underscoring the enormity of a hawkish shift that has taken place in just a matter of months, officials were evenly split on the need for an interest rate increase this year as recently as September.
The hawkish pivot from Fed policymakers took the wind out of a rally under way in the US stock market and sent Treasury prices sliding, as traders dialed up their bets on how aggressively the central bank will move to tame inflation.
The S&P 500 gave up an advance of as much as 2 per cent earlier in the day to trade just 0.3 per cent higher.
Yields on Treasuries jumped higher, with the most intense increases registered in shorter-dated notes that are sensitive to policy moves. The yield on the two year note jumped 0.12 percentage points to 1.97 per cent, its highest level since May 2019. Yields rise when a bond’s price falls.
The benchmark 10 year Treasury yield climbed 0.06 percentage points to 2.21 per cent, also its highest since 2019.
The Fed’s embrace of much tighter monetary policy comes despite a sharp escalation in tensions stemming from Russia’s invasion of Ukraine, which is broadly expected to dent growth and intensify price pressures. The European Central Bank also adopted a more aggressive stance this month, scaling back its bond-buying plan as the war boosted inflation expectations.
In its policy statement released on Wednesday, the Fed acknowledged the geopolitical uncertainty clouding the outlook, but emphasized that the conflict is likely to create “additional upward pressure on inflation and weigh on economic activity”.
While the central bank has in the past delayed making big policy decisions in periods of acute conflict to avoid exacerbating volatility at a turbulent time, surging inflation and an extremely strong labor market have prompted the Fed to press ahead with plans to more substantively tighten monetary policy .
Fed officials on Wednesday also revised higher their forecasts for inflation, which is derived from the personal consumption expenditures price index. The median estimate for year-end core inflation, which strips out volatile items such as food and energy, rose to 4.1 per cent, up from 2.7 per cent in December. Next year’s estimates also rose, with most of the officials now forecasting the core PCE index to hover at 2.6 and 2.3 in 2024. It currently stands at 5.2 per cent, well above the Fed’s 2 per cent target.
The median estimate for US economic growth also moderated to 2.8 per cent from the 4 per cent pace projected in December, while the forecast for the unemployment rate held steady at 3.5 per cent. A majority of Fed officials saw the unemployment rate rising to 3.6 per cent in 2024.
The Fed also hinted at its plans to reduce its enormous balance sheet, which more than doubled in size over the course of the pandemic to $ 9tn as the central bank hoovered up government bonds as part of its efforts to shore up the economy. It said the committee expects to begin reducing its holdings of Treasuries agency mortgage-backed securities “at a coming meeting”.