The U.S. Federal Reserve on Wednesday approved its first rate hike in more than three years and signaled it was on the way as part of its efforts to combat inflation driven by high oil prices and other factors.
In a move widely expected by markets, the central bank’s Federal Open Market Committee voted 12-0 to raise key interest rates by a quarter of a percentage point (25 basis points). This measure brought the overnight interest rate to the target range of 3.75-4%.
“Inflation remains elevated,” the committee said in a brief statement after the meeting. “Today’s policy actions will support a timely return to the Commission’s 2% target. The Commission will achieve price stability.”
Inflation has been “too high for far too long,” Chairman Kevin Warsh said at a press conference.
“We must be confident that underlying inflation is moving clearly and fast enough toward our goals,” he said. “Today, the FOMC determined that this standard has not been met.”
Mr. Warsh further explained that recent economic reports indicate that the economy, including the labor market, is strong. However, it added that inflation remains above the central bank’s target and tensions in the Middle East also contributed to the decision.
“All three points contribute to today’s unanimous and firm decision,” he said.
highly anticipated
Despite a number of contradictory statements from policymakers recently, markets were pricing in a more than 90% chance that the FOMC would approve the rate hike, although there was some chatter about the possibility of multiple dissenting voices.
Sustained high inflation and Mr. Warsh’s comments a few weeks ago had Wall Street confident that the Fed would approve its first interest rate hike since July 2023.
The committee’s latest forecast released on Wednesday showed that a majority of officials believe further rate hikes later this year are possible.
A dot-plot grid of individual officials’ forecasts showed that 16 out of 18 participants (Mr. Warsh has chosen not to submit dots since taking office) expect further rate hikes, with four of them expecting two more possible rate hikes. Two participants expected the committee to finish with one raise.
However, no increases are shown for subsequent years, with one reduction each shown in 2028 and at least one reduction shown in 2029.
Officials also slightly raised their inflation expectations for this year.
They see the aggregate value of the Personal Consumption Expenditure Price Index at 3.7% and the core value excluding food and energy at 3.4%, both up 0.1 percentage point from the previous update in June. The Fed doesn’t expect its inflation target to be met until 2029, but sees both measures plummeting to 2.3% headline and 2.5% core in 2027.
The committee meeting has been on hold for most of the year and was expected to remain so until the tide began to turn toward rate hikes in late August.
The Fed rarely moves at all.
That’s because the Fed rarely moves once, and policymakers typically avoid making gradual decisions when they think inflation is too high and a rate hike is necessary, or when growth is too slow and the central bank wants to stimulate demand with low interest rates.
Although the Fed’s action was expected, the rationale for raising interest rates was unusual.
The Fed generally scrutinizes what kind of inflation the economy is currently experiencing, including rising fuel costs from the Iran war and the lingering effects of tariffs. But officials in recent days have been weighing the costs of continuing to raise prices, especially as the labor market stabilizes. The committee lowered its forecast for the unemployment rate to 4.1%, down 0.2 percentage points from June.
The current concern is that longer-term energy prices could raise inflation expectations, which could begin to ripple through the economy. Economists also see increased investment in artificial intelligence as a potential source of inflation.
And the “blip” episode from a few years ago is still fresh in policymakers’ minds, as Fed officials believed the supply and demand shock from the coronavirus pandemic would eventually wear off. In fact, inflation reached a 40-year high before the Fed decided to act.
The July debate generated considerable disagreement over policy views, with three FOMC members voting against the decision to hold the debate and instead favoring a quarter-point rate hike.
At this week’s meeting, the situation for 2027 was very much in doubt, with eight officials pointing to further rate hikes, six saying they would leave the funds rate unchanged, and four expecting a rate cut.
Markets are already pricing in higher interest rates across all sectors. of S&P500 It rose after Wednesday’s announcement.
Government bond yields are rising rapidly. The 10-year bond has risen about a quarter of a point since Warsh’s remarks at the Fed’s Aug. 28 symposium in Jackson Hole, Wyoming. The benchmark value is up about 1 point from February’s low. Two-year bonds, which are most sensitive to interest rate expectations, have seen an even sharper rise.
Borrowing costs are also on the rise. According to Mortgage News Daily, 30-year fixed-rate mortgage rates rose to 7.19%, up about 38 basis points since the Jackson Hole speech and more than 1 percentage point higher than a year ago.
U.S. Treasury yields fell following the decision, showing investors encouraged by the central bank’s attempts to rein in inflation. Yields and prices move in opposite directions.
“Today’s FOMC meeting could be the moment when the FOMC regains some sanity,” said Brad Conger, chief investment officer at Hartl & Company. “There were many arguments for stopping, but this time the committee sided with the high street.”
“Fear of inflation is pervasive, and that uncertainty is hampering decision-making for all companies. One swallow is not a springboard, but we may have just glimpsed Volkerian decisiveness, as opposed to the eternal sycophant of the Powell era,” Conger added.
