US Federal Reserve predicts potential interest rate hike as early as next year

The Federal Reserve Building, Washington, August 22, 2018.

Chris Wattie / Reuters

The Federal Reserve signaled on Wednesday that it could start raising its benchmark interest rate sometime next year, sooner than it expected three months ago and a sign that it feared that high inflationary pressures would persist.

In a statement, the Fed also said it would likely start slowing the pace of its monthly bond purchases “soon” if the economy continues to improve. The bond purchases were aimed at lowering long-term loan rates in order to encourage borrowing and spending.

Taken as a whole, the Fed’s plans reflect its belief that the economy has recovered sufficiently from the pandemic recession that it can soon begin to recall the extraordinary support it provided after the coronavirus crippled it. savings 18 months ago. While the economy has steadily strengthened, inflation has also accelerated to a three-decade high, increasing pressure on the Fed to pull out.

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The economy has recovered faster than many economists expected, although growth has slowed recently as COVID-19 cases have increased and labor and supply shortages have increased. hampered manufacturing, construction and some other sectors. The US economy has returned to its pre-pandemic size and the unemployment rate has fallen from 14.8% shortly after the pandemic to 5.2%.

At the same time, inflation surged as resurgence in consumer spending and disruption in supply chains combined to create shortages in semiconductors, cars, furniture and electronics. Consumer prices, according to the Fed’s preferred measure, rose 3.6% in July from a year ago – the biggest such increase since 1991.

In its updated quarterly projections, Fed officials now plan to hike their short-term policy rate once in 2022, three times in 2023 – one more than they expected in June – and three times. in 2024. This benchmark rate, which influences many consumers and business loans, has been stuck near zero since March 2020, when the pandemic erupted.

Before starting to raise rates, however, the Fed expects to start cutting or cutting back on its monthly bond purchases. The central bank had signaled last year that it would likely start cutting its $ 120 billion a month treasury bill and mortgage bond purchases once the economy made “further substantial progress” towards the Fed’s targets of maximum employment and 2% average. annual inflation.

“If progress continues broadly as planned, the Committee believes that a moderation in the pace of asset purchases may soon be warranted,” the Fed said in a statement released after its two-day meeting ended Wednesday.

Overall, the decline in Fed bond purchases and its possible rate hikes, whenever they happen, will mean some borrowers will have to pay more for mortgages, credit cards, and business loans. .

Most economists expect the central bank to officially announce at its next meeting in November that it will start cutting its bond purchases in December. The Fed has not hinted at how fast it will cut back on buying. But it is expected to significantly reduce its purchases of treasury bills by $ 10 billion per month and $ 5 billion of mortgage-backed securities.

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The tricky task for the Powell Fed is to explain how it will soon begin to withdraw economic support while reassuring investors, consumers and business leaders that it will not act so fast it will derail recovery from recession. Powell has repeatedly expressed his belief that the current high level of inflation will subside as the economy normalizes – and partly for this reason, has said the central bank is not yet close to raising prices. interest rate.

But changes in the Fed’s interest rate projections suggest the central bank is gradually moving closer to it. In March, the 18 officials who make up its policy-making committee predicted that they would not hike rates at all until 2023. In June, the committee revised its forecast to two rate hikes in 2023. And now , he sees a rate hike as early as next year.

In its latest forecast, policymakers also say they expect the economy to grow more slowly this year, to 5.9%, down from its June projection of 7%. It forecasts an inflation rate of 4.2% by the end of this year, but raised its inflation projection next year to just 2.2%, from 2.1%.

Powell is also grappling with a major ethical issue surrounding the investments and transactions of some regional Fed bank chairmen. Robert Kaplan, chairman of the Federal Reserve Bank of Dallas, revealed in financial reports that he traded millions of dollars in individual stocks like Amazon, Chevron, Facebook and Google in 2020 as the Fed took extraordinary action to stimulate the economy.

Eric Rosengren, Chairman of the Boston Fed, last year invested in real estate investment trusts that held mortgage-backed bonds of the type that the Fed buys as part of its efforts to cut lending rates . And Powell himself owns municipal bonds, which the Fed bought last year for the first time to support this market.

A spokesperson said last week that the Fed was taking a “fresh and complete look” at its rules regarding the financial holdings of its officials. The investments were allowed under current Fed rules, and Rosengren and Kaplan have agreed to sell their holdings and reinvest the proceeds in index funds and cash.

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The Fed’s expected policy changes are following similar steps by other central banks in the developed world as growth and inflation accelerate in many countries. The European Central Bank said earlier this month it would cut its bond purchases, although it has yet to say it will end it. The central banks of Canada and Australia also cut their bond purchases.

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