WASHINGTON/SAN FRANCISCO- Federal Reserve officials are likely to hit a key milestone this week with an interest rate hike that effectively ends pandemic-era support for the US economy and begins to test whether growth can continue without the central bank’s active help.
The Fed is expected to raise its benchmark overnight interest rate by three-quarters of a percentage point to a target range of 2.25 percent to 2.50 percent at the end of a two-day policy meeting on Wednesday. That would match the high hit before the COVID-19 pandemic and lift rates to a level officials see as roughly “neutral,” or no longer supporting the economy, over the long run.
With that benchmark in view, the debate shifts to questions that will determine whether the economy can avoid a recession in coming months: How low will inflation need to fall before Fed officials conclude it is under control? How high will rates need to rise for that to happen? And how much of a cost will be paid in terms of slower economic growth and rising joblessness?
Fed officials coalesced behind aggressive rate hikes as they watched inflation accelerate this year. But there is little precedent for the moment they now face, and little clarity on how monetary policy will be set once inflation begins to ease and as they begin to interpret the outlook differently.
“As long as inflation is as high as it is, and no sign of abating, you are going to have a united front,” said Luke Tilley, chief economist at Wilmington Trust. The Fed’s preferred inflation measure is running at a four-decade high of more than 6 percent, roughly triple the formal 2 percent target.
But even with officials promising a full-tilt battle against destabilizing price increases, it may take as little as two months of slowing inflation for “the hawks and the doves … to make themselves known pretty quickly,” with renewed debate over how much risk it is reasonable to take with the economy to drive inflation down another notch, he said.
Hawks and doves is central-bank shorthand for the tension between policymakers more concerned about the risks of inflation – hawks – and those who prioritize the Fed’s other goal of maximum employment – doves.
That has become a hard distinction to draw when all policymakers say they are prepared to raise rates as high as necessary to cool inflation.
So far, there’s been no real decision to make except how large a rate increase to approve at each policy meeting.
Inflation has actually accelerated since the Fed began raising rates in March, prompting officials to shift from the quarter-percentage-point increase that month to a half-percentage-point hike in May and to a 75-basis-point increase in June. That’s a trajectory not seen since former Fed Chair Paul Volcker’s battle with inflation in the 1980s.
At a news conference on Wednesday, Fed Chair Jerome Powell may start to shape expectations for the next policy meeting in September, but be reluctant to speak much beyond that.
The US unemployment rate, meanwhile, has remained at a low 3.6 percent since March, with more than 350,000 jobs being added monthly and leaving little sense yet that policymakers have reached a point where their efforts to control inflation require a direct tradeoff in terms of jobs.
Rate increases are intended to ease inflation by slowing the economy overall. That can also lead to rising unemployment and even an outright recession.
At the Fed’s June 14-15 meeting, even the least aggressive policymaker projected a federal funds rate above 3 percent by the end of this year, which would be the highest since the 2007-2009 financial crisis ushered in an era of low interest rates and benign inflation.
The current pace of job creation is “way too high. That’s why there is no real dispute within the (Federal Open Market) Committee,” said Ethan Harris, the head of global research at Bank of America, referring to the Fed’s policy-setting body.
Similarly, the current unemployment rate isn’t considered consistent with 2 percent inflation and “they need to see some evidence it is picking up” to gain confidence that inflation will move persistently lower, Harris added.
