The Federal Reserve announced Wednesday it will raise its key interest rate by 0.75% as it seeks to fight sky-high inflation.
It’s the second time in a row the Fed has raised rates by three-quarters of a percentage point, and the fourth rate hike of 2022. The reason for the hikes: Prices for goods and services are climbing at the highest rate in four decades. Last month, they surged more than 9% compared with June of last year.
By raising interest rates, the Fed is hoping to reduce overall demand in the economy, which in turn should slow down price growth.
In its statement Wednesday, the Fed said there are signs the rate increases are working.
“Recent indicators of spending and production have softened,” the bank said, adding that, at the same time, job gains are robust and the unemployment rate is low, despite inflation.
The Fed also cited Russia’s war against Ukraine as a key source of inflation, while suppressing overall global economic activity.
Prices for consumer goods have been sitting at 40-year highs for months now, which is why the Fed has been lifting the key interest rate. Wednesday’s increase is the fourth rate increase of 2022.
While many individual households are struggling, U.S. consumers still have approximately $2 trillion in savings from the pandemic in aggregate, said PNC Chief Economist Gus Faucher. Combined with a stable base of employment, those savings have allowed households to withstand much of the inflationary environment, he said.
Still, it is not clear whether the Fed will be able to accomplish the balancing act of lowering price growth while avoiding broader economic damage. Many economists are now worried about both the inflation rate, which has reached a four-decade high, and gross domestic product (GDP), which could show that the U.S. economy has contracted for two-consecutive quarters — the technical definition of a recession. Thursday, the Bureau of Labor Statistics will release the latest GDP figures.
Even though some economists use GDP to gauge whether the economy is in a “technical” recession, only the National Bureau of Economic Research, a private, non-partisan group, has the power to officially make such a declaration.
In a note to clients last Friday, Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, wrote that U.S. output is falling at a rate not seen since 2009, excluding pandemic months.
“Manufacturing has stalled and the service sector’s rebound from the pandemic has gone into reverse, as the tailwind of pent-up demand has been overcome by the rising cost of living, higher interest rates and growing gloom about the economic outlook,” Williamson said.
There are still some bright spots in the economy. Unemployment remains low at 3.6% and the job market is still strong. While the Fed focuses on tightening monetary policy, it remains to be seen how well its efforts will translate across the broader economy.