Biggest jump in decades: Inflation forces the US Federal Reserve to take radical interest rate hikes

Biggest leap in decades
Inflation forces US Federal Reserve to take radical interest rate hikes

The US Federal Reserve is raising interest rates by 0.5 percentage points in response to high inflation. The Fed last took such a step more than 20 years ago. For the central bankers, the decisions taken are a balancing act.

In view of the rapidly rising prices, the US Federal Reserve has raised the key interest rate more than it has in more than 20 years. The currency watchdogs around Fed boss Jerome Powell decided unanimously to increase the rate by half a percentage point to the new range of 0.75 to 1.00 percent. Experts had expected this aggressive step after the central bank had initiated the turnaround in interest rates in March with an increase of a quarter of a percentage point. Experts are expecting a series of further strong increases in the coming months. “Inflation is way too high,” Central Bank Governor Powell told reporters. “We are acting quickly to lower them again.” At the next meetings of the Central Bank Council, increases of 0.5 percentage points should therefore be forthcoming again, he said.

S&P 500 4,293.23

The consequences of the Russian war of aggression in Ukraine, for example with regard to the energy and food markets, are increasing inflationary pressure and are likely to weigh on the economy, the Fed said. The corona lockdowns in China are also likely to cause new problems in global supply chains, which could affect inflation and growth. The Central Bank Council is therefore very focused on the inflation risks, it said. The Fed is currently under a lot of pressure because the inflation rate is at its highest level in decades. Persistently high inflation is reducing consumers’ purchasing power. In March, for example, prices rose by 8.5 percent compared to the same month last year – the highest level in over 40 years.

This reduces the purchasing power of consumers, which can set off a dangerous wage-price spiral. The Fed is therefore under pressure to tighten the reins further. According to observers, the key interest rate could be at or just above 2 percent by the end of the year. The Fed also wants to quickly reduce its balance sheet, which has swollen to around nine trillion US dollars as a result of the Corona emergency programs. Starting in June, a total of $47.5 billion in assets that are due to expire each month will not be renewed, the central bank announced. By September, the monthly total is expected to increase to $95 billion. This will withdraw further liquidity from the markets and make credit more expensive.

Fed Chairman Powell said at the end of April that the aim was to use the central bank’s tools in such a way that supply and demand adjusted again and inflation went down. The economy should cool down in a way that does not correspond to a “recession”. The balancing act will not be easy, he said. “It’s going to be a big challenge. We’re going to do our very best to make it happen,” Powell promised.

Investors react with relief

Increases in the key interest rate make credit more expensive and curb demand. This helps bring down the rate of inflation, but it also weakens economic growth. It is therefore a dangerous balancing act for the central bank: it wants to raise interest rates so much that inflation is slowed down – without stalling the economy and the labor market at the same time.

The Fed is committed to the goals of price stability and full employment. The US economy is now booming again, with the unemployment rate recently falling to a low 3.6 percent. In view of the high inflation rate, the Fed stopped buying securities worth billions in March and raised its key interest rate by 0.25 percentage points for the first time since the Corona crisis. The last time there was an increase of 0.5 percentage points was 22 years ago. In May 2000, the interest rate had risen to 6.5 percent – shortly before the Internet bubble burst, the consequences of which led to a series of reductions in the key interest rate from 2001 onwards.

Equity investors reacted with relief immediately after the announcement of today’s rate hike. The leading indices Dow Jones, Nasdaq and S&P 500 each rose by more than half a percent. Investors also stocked up on government bonds. That pushes the 10-year T-bond yield down to 2.9773 from 2.9891 percent. The dollar index, which reflects the exchange rate against major currencies, fell, falling 0.2 percent to 103.21 points immediately after the announcement. The Fed’s half-a-point hike in key interest rates is reassuring as some investors feared a 0.75-point hike, said Naeem Aslam, chief market analyst at brokerage firm AvaTrade.

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