The US central bank could accelerate Wednesday’s rate hike with a 0.75% hike.
The acceleration in US inflation measured in May (8.6% year over year) sent financial centers into panic on Monday while market prices rose. In the face of this ever-increasing threat, the Federal Reserve will announce on Wednesday evening at least a 0.50% increase in its key interest rate. Since Monday, many banks and media that have been well presented to the Monetary Committee have seen the Fed go so far as to decide on a 0.75% increase. A gesture of this magnitude would raise to 1.75% the rate at which the US central bank allows banks to lend themselves extremely short-term liquidity.
We haven’t seen such a sharp rise since 1994. The unexpected 1% jump in the Consumer Price Index, which was announced on Friday, changed investor expectations. Those who bet on an early slowdown in inflation are still caught by surprise.
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In its letter, the Fed will undoubtedly do everything to suggest that it is preparing to increase the “federal funds” again by 0.5%, or even more, on July 27, and then by the same amount again on September 21, when the next meetings. Many banks even believe that sharp rate hikes will continue on November 2 and December 14.
After keeping its key rate at zero from March 2020 to February 2022 in order to combat the economic downturn caused by restrictions, the Federal Reserve finds itself mired in hyperinflation unprecedented for more than forty years. This delay in taking the measure of evil that is eroding Americans’ purchasing power justifies a strong monetary policy correction. Elsewhere in the world, the UK, Canada and Australia have also embarked on this move to raise interest rates, while the European Central Bank will enter the dance in July.
The Federal Reserve must not only act decisively, but also commit to doing so sustainably. It is trying to restore credibility. While growth is between 1-2% year-on-year and inflation is at least four times higher than its 2% target, the central bank is still very far from returning to so-called “neutrality”. Economists talk about a neutral key rate when its level neither stimulates nor slows activity.
Above all, the Fed is trying to prevent inflationary expectations from taking hold in the minds of consumers and investors. The more time passes, the more often you will see price increases fueling demand for wage increases to catch up. However, if these wage increases were not accompanied by gains in productivity, they would only sustain a headlong rush that would incorporate inflation into American life. Such a return to the 1970s should definitely be avoided.
The very favorable employment situation (3.6% unemployment) also justifies the tightening of monetary policy. Labor shortage is a major source of price hikes. A sharp increase in the cost of credit should not have a very negative effect on employment for several months.
The last reason for the rapid return of critical orthodoxy is political. Last month, when he greeted Central Bank Chairman Jerome Powell at the White House, President Biden gave his tacit blessing to the Federal Reserve’s offensive against inflation that has shocked America. Janet Yellen, the Treasury secretary who served as Powell from 2014 to 2018, also supports his successor. In Congress, on Wall Street, and in public opinion, prioritizing the fight against inflation is not a topic of debate either. This is the perfect time to attack hard, because this exceptional squad won’t last. At the first signs of low activity or a rising unemployment rate, the anti-inflationary consensus will fade.
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