Fed raises interest rates by half a percentage point – biggest increase in two decades – to fight inflation

The Federal Reserve on Wednesday raised its benchmark interest rate by half a percentage point in its most dramatic move in the fight against high inflation in a generation.

Along with the rate hike, the central bank said it will begin to reduce its asset holdings over $9 trillion balance sheet. The Fed has been buying bonds to keep interest rates low and money flowing through the economy, but the rise in prices has called for a drastic rethink of monetary policy.

The plan outlined on Wednesday will see the balance sheet reduction come in phases as the Fed will allow a cap on the proceeds of maturing bonds that pay monthly while rolling over. the remaining quarter. Starting June 1, the plan will see $30 billion in Treasuries and $17.5 billion in mortgage-backed securities launched. After three months, the limit on Treasuries will increase to $60 billion and $35 billion for mortgages.

These numbers are in line with discussions at the last Fed meeting as described in minutes from the session.

Market prepared for both moves but nonetheless fluctuated throughout the year. Investors have counted on the Fed as an active partner in making sure markets do well, but soaring inflation calls for more tightening.

The market is now looking forward to the central bank continue to increase interest rates strongly in the coming months, with a 75 basis point increase likely in June. Wednesday’s rate hike will push the federal funds rate to around 0.75%-1% and current market prices have rate increases to 3%-3.25% by year-end, according to CME Group data.

Wednesday’s statement noted that economic activity “died in the first quarter” but noted that “household spending and business fixed investment remained strong.” Inflation “remains high,” the statement said.

Finally, the statement addressed the Covid outbreak in China and the government’s efforts to address the situation.

“In addition, the COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Commission pays close attention to inflation risks,” the statement said.

Although some Federal Open Market Committee members have pushed for larger rate hikes, Wednesday’s move received unanimous support.

The 50 basis point increase was the biggest increase the rate-setting FOMC had set since May 2000. Back then, the Fed was battling the excesses of the early dotcom and internet bubble. This time, the situation is a little different.

When the pandemic hit in early 2020, the Fed cut the benchmark fund rate to the 0%-0.25% range and instituted an aggressive bond-buying program, more than doubling its balance sheet. its budget to about $9 trillion. At the same time, Congress passed a series of bills that put more than $5 trillion in fiscal spending into the economy.

Those policy moves come at a time when supply chains are congested and demand is soaring. Inflation over a 12-month period up 8.5% in Marchas assessed by the Bureau of Labor Statistics’ consumer price index

Fed officials for months dismissed rising inflation as “transient,” then had to rethink that view as the pressure persisted.

For the first time in more than three years, FOMC in March approved a 25 basis point increase, suggesting that deposit rates could rise to just 1.9% this year. Since then, however, many statements from central banks pointed out a good rate to the north of it. Wednesday’s move marks the first time the Fed has raised rates at consecutive meetings since June 2006.

Stocks have tumbled for the year, with the Dow Jones Industrial Average down nearly 9% and bond prices also plummeting. The yield on the benchmark 10-year Treasury note, which moves inversely to price, was around 3% on Wednesday, levels not seen since late 2018.

The last time the Fed drastically raised interest rates, raising the deposit rate to 6.5% but was forced to withdraw only seven months later. With the combination of the ongoing recession plus the terrorist attacks of September 11, 2001, the Fed was quick to cut, eventually lowering the deposit rate to 1% in mid-2003.

Some economists fear the Fed could face a similar predicament this time – not acting on inflation when it’s running high then tightening in the face of slowing growth. GDP shrank 1.4% in the first quarter, although it was held back by factors such as a surge in Covid cases and a slowdown in inventories that are expected to fall on the year.

This is breaking news. Please check back here for updates.