Frankfurt For the US Federal Reserve (Fed), this is the beginning of a new monetary policy strategy: It is raising its key interest rate by 0.25 percentage points to a range of 0.25 to 0.5 percent. The Fed announced this on Wednesday evening.
It is the first interest rate hike since December 2018. More are likely to follow, as the statement states.
“The US economy is very strong and quite capable of withstanding tighter monetary policy. The probability of a recession is currently not particularly high,” said Fed Chair Jerome Powell in the subsequent press conference. Nonetheless, Powell emphasized being cautious and prudent in order to be able to react quickly to possible unforeseen developments.
Overall, the Fed is preparing investors to raise interest rates by 0.25 percentage points at each of the six further meetings this year. The US interest rate would then be in the range of 1.75 to 2 percent at the end of the year. In December, Fed members had expected three rate hikes on average.
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In addition, the US Federal Reserve expects to announce “in coming meetings” that it will reduce its balance sheet. However, the Fed left the details open. The balance sheet total has grown to a good nine trillion dollars in the course of the pandemic. Expiring bonds would then no longer be fully replaced. This would deprive the market of liquidity.
With the measures, the Fed wants to combat the recently sharp rise in inflation. Consumer prices rose 7.9 percent in February, the strongest increase in 40 years. Powell admitted earlier this month that inflation was too high. In the medium term, it is aiming for an average inflation rate of around two percent.
James Bullard, head of the regional central bank in St. Louis, had therefore spoken out in favor of raising interest rates by half a percentage point at the current meeting. So the Fed’s decision was not unanimous.
The Fed stressed that the effects of the Ukraine war on the US economy “are very uncertain”. In the short term, however, “they could put additional pressure on inflation and economic activity,” the statement said.
The central bankers have revised their expectations for US economic growth downwards, but they are still assuming “strong growth”, as Powell emphasized. The gross domestic product (GDP) of the world’s largest economy is expected to grow by 2.8 percent – 1.2 percentage points less than forecast in December.
Unemployment could fall from the current 3.8 percent to 3.5 percent and remain at this level in the coming years. Demand for jobs is “very strong,” Powell said.
Interest rate path is likely to become steeper
“The Fed is positioning itself as a hawk,” said David Kelly, chief strategist at JP Morgan, on CNBC. Monetary hawks are signaling a tough stance on fighting inflation, unusual for Fed Chair Powell.
The rate hike of 0.25 percentage points had been expected by economists and investors. What is surprising, however, is that monetary policymakers are expecting an average key interest rate of 2.8 percent for 2023 and 2024.
This would mean that the key interest rate would be above the so-called neutral interest rate, which neither stimulates nor dampens the economy. This is currently estimated at around 2.4 percent. The Fed is thus indicating that it will not only miss its inflation target of two percent this year, but also in the next two years.
The US Federal Reserve Chairman has to find a difficult middle ground.
(Photo: dpa)
The interest rate path should therefore become somewhat steeper than previously expected. The leading index Dow Jones and the market-wide S&P 500 turned negative after the Fed decision. The tech index Nasdaq also gave up some of its gains.
In return, the yields on the relevant ten-year US Treasury bonds rose slightly from 2.1938 percent to 2.2386 percent on the bond market. At the beginning of the year, this value was still around 1.5 percent.
Fighting rising prices is complicated for the Fed. If the Fed raises rates too quickly, it risks a recession. However, being too hesitant is also risky, warned Harvard economist Larry Summers in the Washington Post on Wednesday. Raising interest rates gradually would lead to stagflation, a period of higher prices and slower growth.
The former Treasury Secretary under US President Bill Clinton expects average inflation and unemployment rates of over five percent in the coming years. And in the end, “stagflation often leads to recessions,” he clarified. In order to regain control of the rapidly rising prices, the key interest rate would have to be at five percent, Summers believes.
More: Bundesbank boss Joachim Nagel in the Handelsblatt interview: “We are experiencing a turning point”