The central bank assumes that “continued increases in the key interest rate will be appropriate,” it said. The Fed’s statement said the impact of the war in Ukraine on the US was “very uncertain”. In the short term, they should create upward pressure on inflation. At the same time, economic growth should be weighed down.
Fed Chairman Jerome Powell stressed that the central bank has an “obligation” to fight rising prices. “We have the tools we need and we will use them,” he said. There is a clear plan to raise interest rates “steadily throughout the year,” Powell said. A plan to reduce the Fed’s balance sheet, which has been swollen by corona aid programs, is also expected to be announced at the next meeting in May, he said. This would further withdraw liquidity from the market, which would roughly correspond to a further interest rate hike. If inflation trends call for even faster action, “then we’ll do it,” he said.
According to a new Fed forecast, several interest rate hikes are to be expected this year. In December, Fed decision-makers on average still assumed that the key interest rate would rise to 0.9 percent over the course of the year – now they are assuming 1.9 percent by the end of this year and even 2.8 percent in the coming year .
Powell said the economy and job market are strong enough to withstand higher interest rates. “The best thing we can do for a strong job market is to ensure a long boom – and that is only possible in an environment of price stability,” Powell told journalists following the interest rate decision. In the medium term, the central bank is aiming for an average inflation rate of around 2 percent.
In the forecast presented on Wednesday, the Fed now expects a significantly higher inflation rate for the current year than three months ago. Despite the planned increases in the key interest rate, the inflation rate is expected to be 4.3 percent at the end of 2022, an increase of 1.7 percentage points compared to the December forecast. The Fed has had to revise its inflation forecasts upwards several times since the beginning of the corona pandemic.
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.
The Fed is committed to the goals of price stability and full employment. The economy is now booming once more 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 regarding a shortage of workers. Consumer prices, on the other hand, rose by almost 8 percent year-on-year in February, the highest level in 40 years. Fed Chairman Powell has repeatedly emphasized how tight the US labor market is. The ratio of open jobs to unemployed is downright unhealthily high.
The Fed significantly lowered its growth forecast on Wednesday. The gross domestic product (GDP) is expected to grow by 2.8 percent, which would be 1.2 percentage points less than assumed in December. In the previous year, the economy had grown by a strong 5.7 percent as part of the recovery from the Corona crisis. The Fed remained optimistic regarding the job market: the unemployment rate is expected to fall further to 3.5 percent by the end of the year.
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 asset purchases of up to $120 billion to provide liquidity to the financial markets and support the economy ended this month following being tapered. This was considered a prerequisite for the first rate hike.
“With inflationary pressures mounting in the US ever more threateningly, it was high time that the US Federal Reserve initiated a normalization of its monetary policy,” commented Elmar Völker, an analyst at Germany’s Landesbank Baden-Württemberg (LBBW). Since the price pressure is likely to be additionally fueled by the consequences of the Ukraine war, it is likely that there will be further interest rate hikes in relatively quick succession.
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 once more following years of record lows.
The euro appreciated despite the Fed’s rate hike, hitting an intraday high of $1.1047. US Treasury bond prices fell slightly. The US stock markets rose.