Fed expected to ramp up inflation fight with big rate hike By Reuters

By Ann Saphir

WASHINGTON (Reuters) -Federal Reserve policymakers on Wednesday are expected to deliver the biggest U.S. interest rate hike in more than a quarter of a century, along with forecasts for heftier increases in borrowing costs this year, their best guesses for how quickly inflation could subside, and at what cost to the job market.

Fed watchers expect the U.S. central bank to raise its short-term policy rate by 0.75 percentage point to a range of 1.50% to 1.75%, the first increase of that size since 1994.

An announcement is due at 2 p.m. EDT (1800 GMT) following the end of the central bank’s two-day policy meeting.

The Fed will also release updated projections for economic growth, inflation, unemployment and interest rates for the next several years from all 18 central bankers. A summary is expected to show a Fed policy rate rising past 3% by the end of this year but perhaps only a moderate cooling in price pressures.

Fed Chair Jerome Powell is scheduled to hold a news conference half an hour after the release of the policy statement and projections.

Traders and economists began this week expecting a half-percentage-point rate hike, as Fed policymakers had for weeks signaled that would be likely for the next couple of meetings, with a downshift in the pace possible by September.

Expectations shifted abruptly on Monday after a Wall Street Journal article, followed by similar reports from other outlets, suggested policymakers were alarmed by worsening U.S. inflation data and were considering a bigger move.

A number of analysts penned notes telling investors the report must have originated at the Fed, meaning that it was the action probably favored by the central bank’s leadership.

“Getting in front of the problem is always better than being behind the curve,” Piper Sandler economists Roberto Perli and Benson Durham wrote, adding that a bigger move now makes it less likely the Fed will have to do more later, but also raises the likelihood of a recession next year.

Powell has said he wants to get interest rates “expeditiously” to a neutral level, defined by most policymakers as around 2.4%, and then higher as needed. By hiking rates in 0.75-percentage-point increments, the Fed would achieve that level by July.

The Fed chief also said he expects the Fed’s fight against inflation to be painful, though he has repeatedly sought to assure Americans the central bank will try to slow the economy and inflation without boosting unemployment too sharply from its current low level of 3.6%.

It was unclear whether a steeper rate hike path puts that ideal scenario out of reach.

“A more accelerated Fed hiking cycle ultimately should help tame inflation pressures but will make it more difficult to thread the needle between lower inflation and a recession,” Deutsche Bank (ETR:) economists wrote in a note to clients on Tuesday. They expect the U.S. economy to enter recession around mid-2023.

Taking place separately, European Central Bank policymakers held a rare unscheduled meeting earlier on Wednesday to address concerns about potential fragmentation in government bond markets in the bloc’s monetary union, officials said.

INFLATION ‘FATIGUE’ HINTS

Fed officials had hoped inflation would be leveling off by now. But supply-side constraints have not eased as expected, average gasoline prices have topped $5 a gallon, and price pressures have not abated as much as Fed policymakers expected as consumers shifted from buying goods to services.

On Wednesday, the Commerce Department reported that U.S. retail sales unexpectedly fell in May, as purchases of motor vehicles dropped and record high gasoline prices pulled spending away from other goods.

The decline is a bit concerning, said Tom Simons, an analyst at Jefferies, as it hints of inflation “fatigue” among consumers whose strong spending has been the mainstay of economic growth since the coronavirus pandemic. “If that were to slow down, that would call into question overall growth,” he said.

Data released on Friday showed inflation accelerating and broadening, with consumer prices rising 8.6% in May from a year earlier, faster even than the 8.3% rise registered in April.

Traders of futures tied to the Fed’s policy rate are now betting on another 75-basis-point rate hike in July and at least a couple of 50-basis-point hikes after that move.

Contracts reflect expectations for the Fed policy rate to end the year in the 3.75%-4.00% range.