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The Federal Reserve ordered another sharp hike in interest rates on Wednesday, and warned that rates will have to go even higher to rein in stubbornly high inflation.
The central bank raised its benchmark interest rate by 3/4 of a percentage point. The rate, which was near zero in March, has jumped 3.75 percentage points over the past eight months. It’s the most aggressive round of rate hikes in decades, but so far has done little to rein in inflation.
“Interest rates have been rising at breakneck speed, and we’re not done yet,” said Greg McBride, chief financial analyst at Bankrate. “It will take some time for inflation to come down from these high levels, even once we start to see some improvement.”
Annual inflation in September was 6.2%, according to the Fed’s preferred standard — unchanged from the previous month. The better-known consumer price index shows that prices are rising even faster, at an annual rate of 8.2%.
Fed Chairman Jerome Powell has warned that getting such severe inflation under control will likely require even higher interest rates than he and his colleagues predicted just two months ago.
“What I’m trying to do is make sure our message is clear,” Powell told reporters Wednesday. “We have some ground to cover with interest rates before we reach that level which we believe is sufficiently restrictive.”
At the same time, Powell said the pace of rate hikes may slow soon, as policymakers take stock of the effect of higher borrowing costs on the economy.
“That time is coming, and it could be coming as soon as the next meeting or the one after that,” Powell said.
Stocks initially rallied on news of smaller rate hikes in December or January, but quickly fell on the prospect that rates will eventually have to rise. The Dow Jones Industrial Average fell more than 500 points or 1.55%. The broader S&P 500 index fell 2.5%.
McBride argues that to rein in inflation, borrowing costs will likely need to remain high for an extended period.
“The mantra for 2023 is ‘higher for longer,'” he said. “When inflation is running at 6, 7, 8% and the target is 2%, it’s going to take a while.”
Rate hikes have an effect, even if inflation remains out of control
Rising borrowing costs have already taken a toll on the housing market. And other sectors of the economy begin to slow. But consumers, still full of money saved at the start of the pandemic, continue to spend money. As a result, the Fed may have to press the brakes harder, for longer, than it would otherwise.
“We see today that there is still some reserve of savings for households, which could allow them to continue to spend in a way that maintains strong demand,” said Federal Reserve Chair Esther George. Bank of Kansas City. “That suggests we may have to keep going for a while.”
Like his colleagues on the Fed’s rate-setting committee, George has expressed a determination to control inflation. But she also warned against raising rates too quickly in times of economic uncertainty.
“I’ve been on the more stable and slower side [rate increases]to start seeing how these effects of a lag play out,” George said last month. “My concern is that a succession of very large rate hikes could cause you to oversteer and not be able to see those turns.
With polls show inflation top voter concern, the Biden administration and most members of Congress have stayed away from the Fed as it tries to control prices. But a handful of Democrats have begun to challenge the central bank’s approach, warning that aggressive rate hikes could put millions out of work.
“We are deeply concerned that your interest rate hikes may slow the economy while failing to slow rising prices that continue to hurt families,” wrote Sen. Elizabeth Warren, D-Mass. , and his colleagues in a letter Monday to Fed Chairman Jerome Powell.
The housing market has already slowed at a breakneck pace, as mortgage rates above 7% for the first time in two decades.
Kansas City homebuilder Shawn Woods said his business grew from selling a dozen homes a month before the Fed started raising rates to less than five.
“Never in my wildest dreams would I have thought that we would go from 3% [mortgage rates] to 7% in six months,” said Woods, president of Ashlar Homes and the Home Builders Association of Kansas City.
“I think we’re going to go about six or eight months,” Woods said. “Generally, housing takes us into downturns and out of them. And I think from a housing perspective, we’ve probably been in a housing slump since March or April.”
Despite the fallout from rising interest rates, Powell said the central bank has a responsibility to keep inflation under control.
“Nobody knows if there’s going to be a recession or not, and if so, how bad that recession would be,” Powell said. “Our job is to restore price stability so that we can have a strong labor market that benefits everyone, over time.”