The Federal Open Markets Committee (FOMC) on Wednesday raised its target interest rates by 75 basis points, the largest rate hike since 1994.
The hike was in line with market expectations, which called for a tightening committee, as the latest inflation figure came in above expectations, hitting a fresh 40-year high at 8.6%. FOMC Chairman Jerome Powell, who is also Chairman of the Federal Reserve, said earlier in May that the committee would approve a 50 basis point hike in June if market data such as the consumer price index (CPI) came in as expected.
Powell explained the rationale for a policy change in a news conference held after the release of the FOMC’s monetary policy decision on Wednesday, citing inflation – which he said has “surprised on the upside again”.
“In the coming months, we will be looking for evidence that inflation has come down,” Powell said. “Ups will continue to depend on incoming data, but either a 50 basis point or 75 basis point increase looks more likely for the next meeting.”
Powell reiterated that the primary objective of the Fed and its FOMC is to bring inflation down to their 2% target. Notably, the committee’s most recent statement removed a line from its earlier statement that read: “With appropriate monetary policy tightening, the committee expects inflation to return to its 2 percent target and the labor market to remain strong.” The FOMC added to this Paragraph, however, added a line stating that it is “strongly committed” to containing inflation to the target rate.
The committee also released its new Summary of Economic Forecasts, a document that summarizes all FOMC members’ analyzes and forecasts for gross domestic product (GDP) growth, the unemployment rate and inflation for this year and the next two.
Participants now expect interest rates to reach 3.4% by the end of the year and 3.8% by the end of 2023, before falling in the following years.
Powell reiterated that, consistent with members’ forecasts, the committee does not expect a US recession to follow. Rather, he said the FOMC is closely monitoring key economic information to be agile when it comes to monetary policy.
“We’re not trying to create a recession,” Powell said.
In his speech, the Fed chairman navigated between what can and cannot influence monetary policy. He explained that while the Fed’s work will largely be an attempt to rebalance supply and demand, policymakers can only deal with the demand side and the main blame for inflation currently lies on the supply side.
Powell cited rising commodity prices due to the war in Ukraine and broader supply chain disruptions as two key issues currently affecting inflation and hence monetary policy.
“Our goal is really to get inflation down to 2% while the job market stays strong,” Powell said. “What is becoming increasingly clear is that many factors beyond our control will play a large part in whether or not that will be possible.”
“If demand falls, you could see inflation falling,” Powell explained, adding that there was no guarantee that such a demand cut, which was theoretically within the Fed’s power, would be successful.
Regarding the labor market, Powell stated that a modest rise in unemployment would not weaken the eventual ability to bring down inflation.
“If inflation falls to 2% and unemployment is 4%, that’s still a historically low level,” he said. “I think that would be a successful result. Of course we are not trying to put people out of work, but without price stability there can be no labor market that we want.”
In particular, the Fed’s balance sheet already appears to be shrinking as quantitative tightening began on June 1st – as said at the previous committee meeting.
Latest data shows the Federal Reserve’s balance sheet is taking a breather after going parabolic at the start of the COVID pandemic. Image source: Fred.
Bitcoin crashed ahead of the release of the new monetary policy statement but started to recover as soon as Powell went live. The peer-to-peer digital currency rose 7.42% to $21,900 as the Fed Chair spoke. Bitcoin is trading at around $21,700 at press time.
