Fed now in ‘firefighting mode’ with largest interest rate hike in decades

The Fed announced the largest interest rate hike since 1994 at a meeting Wednesday, raising its federal funds rate by three-quarters of a percent.

The Fed’s benchmark short-term loan rate will now hover at 1.5% to 1.75%.

The increase is a response to the recent inflation increases, which significantly outpaced the Fed’s expectations earlier in the year. The change in the Consumer Price Index, a measure of inflation, reached a 40-year high of 8.6% in May. The Federal Reserve aims to keep inflation around 2%.

“My colleagues and I are acutely aware that high inflation imposes significant hardship, especially on those least able to meet the higher costs of essentials like food, housing, and transportation,” said Fed Chair Jerome Powell at a press conference, adding bringing inflation down is “essential.”

The move forecasts more large increases going forward. By the end of 2022, some economists estimate the rate could reach 3.25% to 3.5%, far overshooting the 1.75% to 2% the Fed forecasted in March.

“To make up for lost time, the Fed is really going to have to scramble,” said Peter Ireland, a macroeconomics professor at Boston College. “Through the summer on into the fall, I think it’s going to be firefighting mode for the Fed.”

The Fed projected on the current trajectory inflation will fall to 5.2% by the end of the year and 2.6% in 2023.

The central bank has attempted to balance slowing inflation with avoiding a recession. Current Fed projections show slower economic growth, at 1.7%, for this year and 2023, lower than March estimates but still escaping a recession.

Economists have said in light of recent trends the Fed will likely at least have to trigger higher unemployment rates, in addition to hitting consumers with the higher mortgage and borrowing costs.

Speculation around inflation and interest rate hikes has also hit the investment market, with the S&P 500 shrinking over 20% this year and signaling a bear market.

Despite the uncertain economic outlook, the interest rate hike Wednesday is broadly seen as a necessary step.

“The outsize move today was a prudent thing, a good thing,” said Ireland, “because the Fed is signaling it understands it’s behind and really needs to act decisively to bring the situation under control.”