The Federal Reserve may respond to soaring inflation with its largest interest rate hike since 1994. At its policy meeting on Wednesday, the central bank may choose to raise rates by 0.75 percentage points, rather than the half point that was reported for weeks.
Why is this important: If the Fed opts for a more aggressive move on Wednesday, it would amount to a move away from the slow and steady rate hike campaign and an escalation of the central bank’s war on inflation – a war that is already causing strong asset price declines and growing recession risk.
- Such a move would deviate from Fed practice in recent years of only taking policy actions that have been telegraphed well in advance to avoid unnecessarily disrupting markets.
- The Wall Street Journal on Monday first reported the possibility of a 0.75 percentage point rate hike, triggering a sharp rise in bond yields as traders weighed the possibility.
The sharper rise in rates will be on the table at the Federal Open Market Committee meeting beginning Tuesday afternoon, with a real possibility of pulling the trigger. The decision will be announced at 2 p.m. ET Wednesday.
State of play: Inflation news has worsened even since the Fed entered its usual “blackout period” 10 days ago, when officials do not give monetary policy speeches or interviews at the approaching a political meeting.
- More importantly, the consumer price index for May far exceeded expectations, with prices soaring across the board.
- But more importantly, there have been new signs that inflation expectations are taking off, which is setting off alarm bells among Fed officials. The University of Michigan consumer sentiment survey showed that Americans expect inflation to be 3.3% a year in the next 5 to 10 years, up from 3% in May.
Between the lines: Had such developments occurred before the blackout, officials might have discussed shifting political views — and the option of a more aggressive tightening — in speeches and interviews. But that was not an option.
- Yet officials up to (and including) Chairman Jerome Powell have publicly stressed that their forecast of a half-percent rate hike hinges on how the economy performs based on their expectations — that which means that when circumstances change, policy options will also change.
another option would be for the central bank’s monetary policy committee to proceed with a half-percentage-point rate hike that has been reported in the past, but gives an explicit indication that rate hikes of 0.75 percentage points will be on the table at future meetings.
- Still, that would raise the question of why not act now if policymakers believe deeper rate hikes are needed to bring inflation down.
The bottom line: More than any Fed policy meeting in recent memory, what the central bank will do this week seems like an open question.