FED raises interest rates by 75 basis points.

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In brief

  • The Federal Reserve raised interest rates by 75 basis points.
  • Fed policymakers expect interest rates to rise to 4.6% by the end of next year.
  • Earlier, they still assumed a peak of 3.8%.

With a third rate hike of 75 basis points in a row, to a range between 3.00% and 3.25%, the Federal Reserve is keeping up the pace to cool down the overheated US labour market. According to Chairman Jerome Powell, the policy rate is only now at the level where the economy is somewhat squeezed. For inflation to return to its 2% target, many more interest rate hikes will be needed.

The so-called dot plot, the point cloud of interest rate expectations of individual policymakers published every three months, shows that they now expect interest rates to stand at 4.4% by the end of this year. In 2023, they expect a final level of 4.6%, to fall to 3.9% in 2024. Three months ago, policymakers still thought the peak would be at 3.8% by the end of 2023. Initially, financial markets were shocked by this. Equity indices fell 1% immediately after the publication of the point cloud, while interest rates rose.

‘Let me be clear, our stance has not changed since Jackson Hole,’ Powell said before seeking to answer the first question at the press conference. At the Jackson Hole conference, Powell suggested that the central banking system takes a recession for granted, just so long as inflation gets under control. That seemed to be the cue for equity markets to hit the ride back up, and bond yields also moved back down.

Combative language

However optimistic the markets want to take Powell’s words, Powell’s language during the press conference remained combative. He continued to stress that the Fed will continue to raise interest rates until inflation is under control, subtly referring to his illustrious predecessor Paul Volcker, who raised interest rates to above 20% and dragged the United States into a deep recession but did get sky-high inflation under his thumb.

‘Without price stability, our economy cannot function properly,’ Powell said. In particular, he pointed to the labour market, which he said is “extremely tight” and where the balance between supply and demand for labour will have to be restored. According to Powell, the economy will have to run below potential for quite some time and for that, unemployment will also have to rise. The Fed expects it to rise to 4.4% next year. That is above the 4.0% the Fed sees as an equilibrium level for the longer term.

Inflation expectations up

Still, the Fed’s new growth forecasts do not point to a recession. Those growth forecasts were, however, revised down significantly. The Fed expects the economy to grow 0.2% this year, down from 1.7% three months ago. For next year, growth is estimated at 1.2%, down from 1.7% in June.

Although the Fed is raising interest rates further, inflation will not return to target for now. In fact, expectations for PCE inflation, which measures the monetary depreciation of personal consumption and is the Fed’s favourite indicator, were revised upwards further. The Fed expects it to rise to 5.4% this year from a previous expectation of 5.2%. The expectation for next year was also raised by 0.2 percentage points to 2.8%. Only by 2025, the Fed thinks that inflation will be back to 2.1%, just above the target.

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