Challenged by the highest level of inflation experienced in the US in over 40 years, the Federal Reserve decided on Wednesday a third consecutive interest rate hike of 75 basis points, bringing the benchmark rate up to a range of 3.0% to 3.25% from 2.25% to 2.50%.
At successive meetings throughout the year, the US Federal Reserve banks have indicated they will continue to pursue more rate hikes, potentially holding the benchmark rate above 4% by the end of the year and for an extended time as inflation persists.
US Federal Reserve Chairman Jerome Powell warned against prematurely lowering rates again in a speech soon after the announcement. In August, Powell had said that the Fed would continue raising interest rates until it was confident the job is done.
Powell admitted the rate hikes would also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain, he said.
The Consumer Price Index, CPI, for August ended up showing an 8.3% year-on-year increase, which was higher than the market forecasts of 7.9% to 8.1%. Although the August CPI data was lower than the over 9% peak seen in June, it also indicated that inflation is not tapering off quickly.
The current inflation has been attributed to several factors including supply issues amid a post-pandemic boom in consumer spending and the fallout from Russia's war in Ukraine. Some hope these factors should prove transitory, meaning the inflation need not necessarily be permanent.
The Fed has also been criticized for contributing to inflation with loose economic policy like keeping interest rates too low for too long, and for continuing to inject money into the economy.
Most Western central banks dropped their rates to unprecedented levels at or near zero in the aftermath of the financial crash, and then kept them there for the better part of 15 years.
Economic tightening by increasing the cost of borrowing money by raising interest rates is a tool central banks can use to cool off the economy by lowering demand. The idea is to discourage borrowing and spending. One of the Fed's central tasks is maintaining price stabilization.
However, aggressive rate hikes also run the risk of ushering in a recession, as overall economic growth is also dampened. Powell has touted the idea of a soft-landing, which means inflation can be brought under control without kneecapping the economy.
However, some critics have said this is wishful thinking, as interest rates would have to far exceed current levels to bring inflation down to a target of 2%.
The last time inflation was this high was in 1980, with a peak of over 14%. Then-Fed chairman Paul Volcker at one point in 1981 raised interest rates to over 20% in order to beat back double-digit inflation, unleashing a deep economic recession.
But Powell seems less drastic, We have got to get inflation behind us, he said. I wish there were a painless way to do that. There isn't.
The Bank of England is widely expected to announce its seventh consecutive rate rise at its meeting this Thursday and like in other central banks, analysts are starting to worry that the global sweep of the rate hikes, which ripple out to the public in the form of more expensive mortgages, loans and credit card debt, could lead to greater economic slowdown than policymakers expect.