US Fed hikes interest rates by 75 basis points for fourth time this year

The US Federal Reserve on Wednesday hiked interest rates by three-quarters of a percentage point, pressing even harder on the brakes of the economy in a scramble to slow inflation.

The Federal Open Market Committee (FOMC), the panel of Fed officials responsible for monetary policy, boosted the central bank’s baseline interest rate range to a span of 3.75 to 4 percent. It is the fourth consecutive 75 basis point hike issued by the Fed and sixth interest rate increase since March.

As the Fed raises its baseline interest rate range, interest rates on mortgages, credit cards, and other loans rise as well. Higher borrowing costs tend to slow the economy as households and businesses have less money to spend on goods and services.

The Fed’s latest hike will add even more financial pressure to a resilient but slowing US economy that some experts believe is on the precipice of recession.

The Fed’s rapid interest rate hikes have caused home sales to collapse and pushed businesses to pull back investment, two major forces that could slow the US economy. Higher Fed interest rates also deepen economic turmoil abroad, which could boomerang on the US.

Inflation has remained stubbornly high as a strong US job market helps support consumer spending and supply shocks — particularly the war in Ukraine — push prices for food and fuel higher. Prices rose 6.2% over the past 12 months, according to the personal consumption expenditures (PCE) price index, the Fed’s preferred inflation gauge.

The Fed has faced growing pressure from some policymakers, especially Democratic lawmakers, to slow down its rate hike campaign amid growing signs of a looming recession. 

Critics of the Fed’s approach argue the bank will needlessly drive millions into unemployment by ignoring clear signs of inflation falling, the lagging effect of Fed interest rate hikes and the bank’s inability to solve supply snarls.

Fed leaders, however, have insisted for months that they will continue to boost interest rates until inflation shows signs of falling toward the bank’s annual 2 percent target. 

 

 

Pakistan must take cue from China

State Bank of Pakistan (SBP) is scheduled to announce its policy rate today (Monday, August 22, 2022). While some of the analysts are demanding a reduction in the interest rate, others fear the central bank may increase the rate. 

If the newly appointed SBP Governor, Jameel Ahmed, is serous in accelerating Pakistan’s GDP growth rate, he must reduce interest rate. Let me reiterate once again that Pakistan suffers from cost-pushed inflation. Therefore, reduction in interest rate is a must for easing inflation.

The SBP Monetary Policy Committee must take a cue from China. It has reduced benchmark lending rates on today, adding to easing measures announced last week. This is one of the signs that Beijing is stepping up efforts to spur credit demand in an economy hobble by a property crisis and a resurgence of COVID infections.

The one-year loan prime rate (LPR) was lowered by 5 basis points to 3.65% at the central bank's monthly fixing, while the five-year LPR was slashed by a bigger margin of 15 basis points to 4.30%.

In a Reuters poll conducted last week, 25 out of 30 respondents predicted a 10-basis-point reduction to the one-year LPR. All of those in the poll also projected a cut to the five-year tenor, including 90% of them forecasting a reduction larger than 10 bps.

Most new and outstanding loans in China are based on the one-year LPR, which is now loosely pegged to the central bank's medium-term lending facility (MLF) rate, while the five-year rate influences the pricing of mortgages.

 

Get ready for another interest rate hike

Today Reuters has released the news saying that slowing US inflation may have opened the door for the Federal Reserve to temper the pace of interest rate hikes, but policymakers have no doubt that the central banks will continue to tighten monetary policy until price pressures are fully broken. 

If rates are raised around the world, Pakistan can’t remain an exception.

A US Labor Department report on Wednesday indicated that consumer prices didn't rise at all in July as compared to June. The policymakers believe it would be a long process, with a red-hot job market and suddenly buoyant equity prices suggesting the economy needs more of the cooling that would come from higher borrowing costs.

The Fed is far, far away from declaring victory on inflation, Minneapolis Federal Reserve Bank President Neel Kashkari said at the Aspen Ideas Conference, despite the "welcome" news in the CPI report.

Kashkari said he hasn't "seen anything that changes the need to raise the Fed's policy rate to 3.9% by year-end and to 4.4% by the end of 2023. The rate is currently hovering between 2.25% to 2.5% range.

To be sure, Kashkari is the Fed's most hawkish member; most of his 18 colleagues believe a little less policy tightening may be enough to do the trick to bring prices under better control.

San Francisco Fed President Mary Daly, in an interview with the Financial Times, also warned it is far too early for the US central bank to declare victory in its fight against inflation.

However, Daly said that a half-percentage point rate rise was her baseline but did not rule out a third consecutive 0.75% point rate rise at the central bank's next policy meeting in September, according to the report.

Calling inflation unacceptably high, Chicago Fed President Charles Evans said he believes the Fed will likely need to lift its policy rate to 3.25% to 3.5% this year and to 3.75% to 4% by the end of next year, in line with what Fed Chair Jerome Powell signaled after the Fed's latest meeting in July.

Still, he said, the CPI report marks the first positive reading on inflation since the Fed began raising interest rates in March in increasing increments ‑ a quarter of a percentage point to start, then a half a point, and then three quarters of a percentage point in both June and July.

After Wednesday's CPI report, traders of futures tied to the Fed's benchmark interest rate pared bets on a third straight 75-basis-point hike at its September 20-21 policy meeting, and now see a half-point increase as the more likely option.

Equity markets took a similar cue on hopes for a less aggressive central bank, with the S&P 500 rising 2.1%.

Financial markets are currently pricing a top fed funds rate of 3.75% by year-end, with rate cuts to follow next year, presumably as policymakers move to counter economic weakness.

Kashkari called that scenario unrealistic, and said Fed policymakers are united in their determination to bring inflation down to the Fed's 2% target. The risk of recession will not deter me from advocating for what's needed to do so, he said.

The consumer price index rose 8.5% in July from a year earlier, the report showed. While that marked a drop from June's 9.1% rate, prices are still rising at levels not seen since the 1970s and early 1980s. Food prices in July were up 11% from the year before, devastating for lower income families in particular.

For the moment, analysts focus on the fact that after months in which accelerating price pressures pushed Fed policymakers to tighten credit conditions faster than at any time since the 1980s, inflation data finally surprised in the other direction.

"The Fed needs a lot more evidence (of slowing inflation)... but this is a good start," said Karim Basta, Chief Economist with III Capital Management.

Data on August consumer inflation will be released on September 13, the week before the Fed meets, and given recent trends in energy and some other prices the report "should also be friendly to the disinflation path and should make a 50 basis point hike the preferred option."

Still, the Fed's battle with high inflation is far from over.

The core consumer price index - which strips out volatile gas and food prices and is seen as a better predictor of future inflation - rose 0.3% from June and 5.9% from a year earlier. The Fed targets 2% inflation based on a different index that is rising at a lower, but still high, rate of more than 6%.

An alternative measure of consumer prices compiled by the Cleveland Fed, known as the Median Consumer Price Index and considered a good view of the breadth of prices pressures in the economy, rose 6.3% on an annual basis in July, compared to 6% in June.

"Overall, prices remain uncomfortably high," wrote High Frequency Economics' Rubeela Farooqi, who stuck with her call for a 75-basis point rate hike next month. "Coupled with strength in job growth and wages, the data support the case for another aggressive rate hike in September."