The quarter-point increase is the first since the Fed slashed rates to zero at the onset of the pandemic.
The Federal Reserve delivered a sharp message Wednesday on the outlook for the U.S. economy this year: Inflation will cool but it's not going away, and Russia's invasion of Ukraine has created a cloud of uncertainty.
Central bank policymakers, who kicked off a series of interest rate increases for the first time in more than three years, were also more pessimistic about GDP growth, given lower congressional spending, the war, and their own efforts to remove the Fed's massive support for the economy.
That means even if Fed Chair Jerome Powell succeeds in his plans to ease the worst price surge in four decades while avoiding a recession, the White House will still have to deal with elevated inflation for the next couple of years without the blockbuster growth it has enjoyed since President Joe Biden took office. And that could dim the Democrats' chances of holding onto Congress during this year's midterm elections.
“They should be on notice that they’re on the clock here,” Skanda Amarnath, executive director of progressive advocacy group Employ America, said of the Biden administration. “Jay Powell and the Fed are on a course to keep raising rates until the economy enters recession or inflation comes down. The White House should be thinking about all the ways they can help bring inflation down.”
The latest forecasts from the Fed demonstrate how economic cycles rarely fit neatly into political ones, with the central bank focusing on the complicated task of cooling inflation without tipping the economy into a contraction, a goal it has often historically failed at. The central bank is projecting it might need to raise rates as many as seven times this year, and another four times in 2023.
“It looks like they took out the bazooka,” said Beth Ann Bovino, chief U.S. economist at S&P Global. “Maybe the Fed was a little late in the game, but the Fed, when they catch up, they come out running.”
Fed officials estimate that inflation will increase by 4.3 percent by the end of the year — which would be a considerable improvement over the 6.1 percent annual rise reported in January but much higher than their previous 2.7 percent forecast for 2022. They expect the economic expansion to slow to 2.8 percent, a significant drop from their last projection, released in December, of 4 percent — although on the high end of what the country has seen over the last decade.
Powell said he might get some help in bringing down inflation this year from factors beyond the central bank’s control, such as workers coming back to the labor force, which would boost productivity. And as the pandemic fades, people might spend more money doing activities rather than buying products, which could relax some of the stress on struggling supply chains.
But higher rates could start to bite into economic activity heading into the second half of the year, particularly as financial markets prepare for even more increases in borrowing costs heading into 2023, he said. Still, Powell said he doesn’t see an economic downturn on the horizon, pointing to strong consumer demand, job growth, and solid household and business balance sheets.
“The probability of a recession within the next year is not particularly elevated,” he told reporters after the Fed meeting.
He also noted that 2.8 percent growth is still “quite strong.” By comparison, GDP grew by 2.2 percent in 2019, the year before the pandemic struck.
Wednesday’s quarter-point increase is the first hike since the Fed slashed rates to zero at the onset of the pandemic. The central bank was already planning to raise borrowing costs in March amid a blistering job market and rapidly rising prices, but Russia’s attack on Ukraine has confused the outlook since surging energy costs could stoke inflation further and, at the same time, slow the economy down.
“The implications of Russia’s invasion of Ukraine for the U.S. economy are highly uncertain,” said Powell, whom Biden has nominated for a second term. “In addition to the direct effects from higher global oil and commodity prices, the invasion and related events may restrain economic activity abroad and further disrupt supply chains, which would create spillovers to the U.S. economy through trade and other channels.”
The Fed is now targeting between 0.25 and 0.5 percent for its main policy rate. If it follows through on the rate hikes envisioned this year, the federal funds rate target would be nearly 2 percent, still near historic lows.
The White House for months has grappled with the political blowback from higher inflation and sought to curb price pressures with measures aimed at unclogging supply chains and improving competition in certain sectors, such as meatpacking and energy.
Amarnath said they can do more, for example on Medicare pricing, to help lower inflation.
Meanwhile, Americans’ frustration with decades-high price increases — on everything from fruits and vegetables to car insurance — is reflected in dour consumer sentiment readings, which have fallen sharply since the start of the year.
“Higher interest rates are certainly scary, especially when people remember what happened in the late ‘70s and early ‘80s,” Bovino said. “But when I think about the impact of higher inflation on people’s pocketbooks, on the feeling that that dollar isn’t giving you much, I probably would choose higher interest rates over inflation.”
