The Federal Reserve will step up the pace at which it withdraws support from the economy as inflation rises, and it plans to hike interest rates three times next year.
In a sharp policy shift, the Fed said on Wednesday it would cut its monthly bond purchases twice as fast as it previously announced, likely ending it in March. The accelerated schedule puts the Fed on track for a rate hike in the first half of next year.
The Fed’s new forecast that it will hike its short-term benchmark rate three times next year is up from a single rate hike it forecast in September. The Fed’s key rate, now close to zero, influences many consumer and business loans, including mortgages, credit cards and auto loans.
These borrowing costs could start to rise in the coming months, although the Fed’s actions do not always immediately affect other lending rates. And even if the central bank hiked rates three times next year, it would still leave its benchmark rate at a historically low level, below 1%.
In a statement released after its last meeting, the Fed said that even with inflation well above its 2% target, it is unlikely to start raising rates until it hits its target of ” maximum employment “. The Fed has not clearly defined when this target will be reached.
The policy change announced by the Fed on Wednesday was pointed out in testimony President Jerome Powell gave to Congress two weeks ago discussing the extraordinary support the Fed has given to the economy after the year’s pandemic. last.
The change reflects Powell’s recognition that with increasing inflationary pressures, the Fed needed to start tightening consumer and business credit faster than it had expected a few weeks earlier. The Fed had previously characterized the spike in inflation as primarily a “transitional” problem that would subside as supply bottlenecks caused by the pandemic were resolved.
The rise in prices persisted longer than the Fed expected, and spilled from goods like food, energy and automobiles to services like apartment rents, restaurant meals and rooms. hotel. It took a heavy toll on consumers, especially low-income households and especially for daily necessities, and canceled the higher wages many workers received.
In response, the Fed is turning its attention away from reducing unemployment, which has fallen rapidly to 4.2% from 4.8% at its last meeting, and to containing rising prices. Consumer prices rose 6.8% in November from a year earlier, the government said last week, the fastest pace in nearly four decades.
The Fed’s new policy change comes with risks. Rising borrowing costs too quickly could stifle consumer and business spending. This, in turn, would weaken the economy and likely increase unemployment.
Yet if the Fed waits too long to raise rates, inflation could get out of hand. He may then have to act aggressively to tighten credit and potentially trigger another recession.
Fed officials have said they expect inflation to slow down by the second half of next year. Gas prices are already out of their peaks. Supply chain bottlenecks in some regions are gradually easing. And the government’s stimulus payments, which helped spur higher spending that boosted inflation, are not expected to return.
Still, many economists expect high prices to persist. That likelihood was bolstered this week by a government report that found wholesale inflation jumped 9.6% for the 12 months ending in November, the fastest year-over-year pace on the records dating from 2010.
Housing costs, including apartment rents and the cost of ownership, which account for about a third of the consumer price index, have increased at an annual rate of 5% in recent months, calculated Goldman Sachs economists. Restaurant prices jumped 5.8% in November from a year ago, a high of nearly four decades, partly reflecting rising labor costs. Such increases will likely keep inflation well above the Fed’s 2% annual target next year.
The Fed’s monthly bond purchases were meant to hold long-term rates to help the economy, but with unemployment falling and inflation to a nearly 40-year high, they are no longer needed.