US makes huge interest rate rise to tame soaring prices

The Federal Reserve said it would increase its key rate by 0.75 percentage points, targeting a range of 2.25% to 2.5%

The US central bank has announced another unusually large interest rate hike as it battles to rein in soaring prices in the world’s largest economy.

The Federal Reserve said it would increase its key rate by 0.75 percentage points, targeting a range of 2.25% to 2.5%.

The bank has been raising borrowing costs since March to try to cool the economy and ease price inflation.

But fears are rising the moves will tip the US into recession.

Recent reports have shown falling consumer confidence, a slowing housing market, jobless claims rising and the first contraction in business activity since 2020.

Many expect official figures this week will show the US economy shrank for the second quarter in a row.

In many countries, that milestone is considered a recession though it is measured differently in the US.

At a press conference, Federal Reserve Chairman Jerome Powell acknowledged that parts of the economy were slowing, but said the bank was likely to keep raising interest rates in the months ahead despite the risks, pointing to inflation that is running at a 40-year high.

“Nothing works in the economy without price stability,” he said. “We need to see inflation coming down…That’s not something we can avoid doing.”

Federal Reserve Chairman Jerome PowellIMAGE SOURCE,REUTERS
Image caption,

Jerome Powell, the head of the US central bank, is under pressure to rein in inflation

How does raising interest rates fight inflation?

Higher interest rates help to fight inflation by raising the cost of borrowing, encouraging people and businesses to borrow less and spend less. In theory that is meant to lead to lower demand and slow price rises – but it also means less economic activity.

Mr Powell said some slowdown was “necessary”.

“We’re not trying to have a recession – and we don’t think we have to,” he added.

As US growth stalls and price rises squeeze households around the world, the International Monetary Fund (IMF) warned this week that the global economy may be teetering on the brink of recession.

Already, some firms in the tech and housing industries – which saw rapid gains in recent years thanks to low borrowing costs – have announced job cuts or plans to slow hiring, citing the market shift

But with inflation soaring, central banks “don’t really have a choice” but to increase interest rates, said economist Pierre-Olivier Gourinchas, director of research at the International Monetary Fund.

Earlier this month, the European Central Bank announced an unexpectedly large rate rise – its first in 11 years. The Bank of England has been raising rates since December, and dozens of other countries have taken similar steps.

“Most central banks are tightening monetary policy,” said Mr Gourinchas. “The big question looking ahead is how quickly can this monetary tightening bring back inflation to reasonable levels.”

How high is US inflation?

Inflation in the US rose to 9.1% last month, driven by higher prices for gasoline, food and shelter. That is well above the Fed’s 2% target – and the fastest rate since 1981.

Efforts to tame price increases at that time led the Fed to raise interest rates to more than 15% and sent the economy into a decline that lasted more than a year.

Wednesday’s rate rise, the fourth since March, will push the rate the Fed charges banks to borrow to more than 2.25%, a level last seen in 2019, just above where rates were in the months before the pandemic hit in 2020.

But businesses and households have grown accustomed to low interest rates, which have rarely risen above 2% since the 2008 financial crisis. And the Fed is also hiking unusually fast, with Wednesday’s rise marking the second 0.75 percentage point increase in a row.

“This is rapidly proving to be one of the most aggressive hiking cycles we’ve seen in recent decades,” said Seema Shah, chief strategist at Principal Global Investors.

“Combatting four-decade high inflation will take a sustained show of strength.”


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