Fed Continues to Battle Inflation with Higher Rates

On July 27, FOMC members voted to raise the Fed funds rate by 75 basis points, or 0.75%. This was the second consecutive meeting that the Fed raised rates by such a significant amount and such drastic action hasn’t been taken since the Volcker era of the early 1980s. As inflation continues to batter consumers’ budgets, further rate hikes are likely in 2022.

The FOMC Continues to Battle Inflation with Higher Rates

At July’s meeting, the FOMC raised the Fed funds rate by an additional 75 basis points. This was the fourth rate hike in 2022 and brought the target range for the Fed funds rate to 2.25% – 2.50%.

Historically, the Fed has often raised rates in 25 basis point increments. However, the current pace of inflation has contributed to more aggressive policy decisions. Despite earlier rate hikes in 2022, consumer prices rose by an annual rate of 9.1% in June. This represents the fastest pace of inflation since November 1981 and a significant concern for the economy – should the rapid inflation persist.

In the past 12 months, prices have increased rapidly for the items consumers buy most. Food prices have risen 10.4%, shelter costs have climbed 5.6%, and energy prices have skyrocketed 41.6%. These higher costs have put pressure on consumers’ budgets, particularly those that are least able to meet the higher costs. Although nominal wages have trended upward, real disposable income has fallen 3.3% in the past year, fueling concerns that inflation could erode demand if not controlled.

Possible Economic Effects of Rising Rates

While higher interest rates can succeed in curbing inflation, there are often adverse consequences from raising rates. These include reduced economic output and a weaker employment market.

In June, the unemployment rate held steady at 3.6% for the fourth consecutive month. By historical standards, this is a low unemployment rate and could indicate that the labor market could withstand a shock fueled by higher rates.

While the labor market remains strong, economic output has showed signs of weakening. GDP contracted by 1.6% in the first quarter and by another 0.9% in the second quarter. Several factors contributed to the decline in GDP. Among these were notable decreases in private inventory investment and residential fixed investment, which are sensitive to rate increases. If rates continue to rise, these areas of the economy could fall into further decline.

2022 Interest Rate Outlook

The next FOMC meeting will be held September 20-21. At this and subsequent meetings, further interest rate hikes are likely, though they may be less significant than the hikes in June and July. After the most recent meeting, Fed Chair Jerome Powell said, “it likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation.”

Controlling the pace of inflation is of the utmost importance but the effects of higher rates often lag policy decisions. As such, the future of interest rates will depend on the pace of inflation, the state of the labor market, and economic output.

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