0.25 basis points
The US Federal Reserve raises interest rates for the first time since late 2018
03/16/2022, 7:02 p.m
The US Federal Reserve is bracing itself against high inflation. As expected, the central bank of the world’s largest economy is raising interest rates. Recently, there had been speculation about further rate hikes this year.
The US Federal Reserve is reacting to the rapidly rising inflation with a turnaround in interest rates. It raised the key monetary policy rate by a quarter point to the new target range of 0.25 to 0.50 percent. The step came almost exactly two years to the day after the key interest rate was pushed to zero after the corona shock. The turnaround is now also the first tightening since the end of 2018 – and probably the start of a series of increases in the current year.
The central bank assumes that further hikes “will be appropriate”. In their interest rate outlook, the monetary watchdogs signaled that they consider a level of 1.9 percent at the end of 2022 to be appropriate. In November they had only estimated a level of 0.9 percent. In the coming year, they even expect 2.8 percent. In addition, the Fed balance sheet, which has been swollen as a result of the Corona emergency programs, is to be reduced soon, which would deprive the financial market of liquidity.
In doing so, they are responding to inflation: consumer prices have recently risen by 7.9 percent, more than they have in 40 years. The consequences of the war in Ukraine should provide further impetus.
Balancing: interest rate hikes must not stifle growth
Increases in the key interest rate slow down demand. This helps bring down the rate of inflation, but it also weakens economic growth. It is therefore a balancing act for the central bank: it wants to raise interest rates so much that inflation is slowed down – without stalling the economy at the same time. In the medium term, the central bank is aiming for an average inflation rate of around two percent.
The first assessments of economists vary. Thomas Gitzel from VP Bank said: “It seems that the Fed is in panic mode. The US Federal Reserve is opening its monetary tightening cycle with a few bangs.” Concerns about the economy are being shelved and the inflation target is further away than assumed. Therefore, there will probably be an increase in key interest rates at all central bank meetings this year. On top of that, the reduction in total assets could withdraw more liquidity from the market than a pure interest rate hike.
For ZEW’s Friedrich Heinemann, the “first small rate hike (…) is more than overdue”. On top of that, he seems “half-hearted”. The central bank must avoid “temporary corona and war inflation turning into a longer-term inflation process. Far higher interest rates are unavoidable for this.” With regard to the labor market, “the first triple step of 25 basis points turned out to be too fearful. The Fed is lagging behind the inflation dynamic with its hesitancy.”
Fed Chairman Jerome Powell told the US Congress earlier this month that the Fed’s goal is to enable a “long upswing” that will continue to ensure a strong labor market. “And that is only possible in an environment of price stability.” A high rate of inflation weakens the purchasing power of consumers because they can buy less for one euro or dollar than before.
One challenge for the US central bank is that it can only influence the causes of price increases to a limited extent. The disruptions in global supply chains and rising energy prices, for example, do not react directly to US interest rates. According to experts, the Russian war of aggression in Ukraine is likely to lead to new problems in the supply chains, as well as further corona lockdowns in China – as recently in the metropolis of Shenzhen.
Turnaround in interest rates still open in the euro area
The Fed is committed to the goals of price stability and full employment. The economy is now booming again and the job market is developing very positively. The unemployment rate had recently fallen to a low 3.8 percent. Many companies are already complaining about a shortage of workers.
In view of the good economic development and high inflation, the Fed had already initiated an important turnaround at the end of last year: Away from the considerable aid programs to fight the Corona crisis and towards a tighter monetary policy. Monthly securities purchases of up to $120 billion to provide liquidity to the financial markets and support the economy ended this month after being tapered. This was considered a prerequisite for the first rate hike.
Europe’s currency watchdogs are now also heading towards an end to their ultra-loose monetary policy. The European Central Bank (ECB) is scaling back its billion-euro bond purchases earlier than planned and has announced that they will end in the summer. It is still unclear when interest rates in the euro area will rise again after years of record lows.