The Fed raised its key short-term rate by three-quarters of a percentage point to a range of 3% to 3.25%

Paul Davidson, USA TODAY
·4 min read

WASHINGTON--The Federal Reserve barreled ahead with a third straight outsize interest rate hike Wednesday in an effort to squash high inflation but economists worry the campaign is increasingly risking a recession by next year.

The Fed raised its key short-term rate by three-quarters of a percentage point to a range of 3% to 3.25%, a higher-than-normal level designed to ease inflation by slowing the economy. It also significantly bumped up its forecast for what that rate will be at the end of both this year and 2023.

Fed officials now predict the key rate will end 2022 at a range of 4.25% to 4.5%, a full percentage point above the 3.25% to 3.5% they projected in June, and close out next year at 4.5% to 4.75%, according to their median estimate. That suggests the central bank could approve another three-quarters point hike at its November meeting and then a half-point rate rise in December.

But within the next year or two, as higher rates restrict economic activity, Fed policymakers expect growth to weaken substantially. The central bank expects to cut the fed funds rate by about three-quarters of a point in 2024, presumably in response to a slowing economy or possibly a recession.

The economy is already pulling back. In a statement after a two-day meeting, he Fed said, “Recent indicators point to modest growth in spending and production” but “job gains have been robust….and the unemployment rate has remained low.”

It added it “anticipates that ongoing increases” in the fed funds rate “will be appropriate.”

Wednesday’s rate increase is expected to reverberate through the economy, driving up rates for credit cards, home equity line of credit and other loans. Fixed, 30-year mortgage rates have jumped above 6% from 3.22% early this year. At the same time, households, especially seniors, are finally reaping higher bank savings yields after years of piddling returns.

Barclays says Fed policymakers had little choice but to lift rates sharply again after a report last week revealed that inflation – as measured by the consumer price index (CPI) -- rose 8.3% annually in August, below June’s 40-year high of 9.1% but above the 8% expected.

Also, employers added a healthy 315,000 jobs in August and average hourly pay increased a hefty 5.2% annually. That could fuel further price increases as companies struggle to maintain profit margins.

Markets that try to predict where rates are headed figured there was an 18% chance Fed policymakers would hoist rates by a full percentage point Wednesday.

But Goldman Sachs economist David Mericle says little has changed since Fed Chair Jerome Powell told reporters in late July that the pace of rate hikes probably would slow to account for the increased risk of recession. Rather, he says, the Fed is partly trying to deliver a message to stock markets that until recently had grown complacent about the prospect of more rate increases.

Growth is slowing as the Fed pushes borrowing costs higher. The Fed said Wednesday it expects the economy to grow just 0.2% this year and 1.2% in 2023, below its June estimate of 1.7% for both years, according to officials’ median estimate.

It predicts the 3.7% unemployment will rise to 4.4% by the end of next year, well above its prior forecast of 3.9%.

And the Fed’s preferred measure of annual inflation – which is different than the CPI – is expected to decline from 6.3% in August to 5.4% by the end of the year, slightly above Fed officials’ previous 5.2% forecast, and 2.8% by the end of 2023. That would be moderately above the Fed’s 2% target.

Even without big Fed rate increases, inflation is expected to slow as supply chain bottlenecks ease, commodity prices fall, a strong dollar lowers import costs and retailers offer big discounts to thin bloated inventories. Powell, though, has said it’s critical that the Fed raise rates to tamp down consumers’ inflation expectations, which can affect actual price increases.

A growing number of economists believe the Fed’s aggressive campaign – its key rate began 2022 near zero -- will tip the economy into recession. Economists says there’s a 54% chance of a downturn next year, up from 39% odds in June, according to a survey by Wolters Kluwer Blue Chip Economic Indicators.

For months, Fed Chair Jerome Powell said he thought the central bank could tame inflation without sparking a recession. But in a speech last month at the Fed’s annual conference in Jackson Hole, Wyoming, he acknowledged that higher rates and slower growth “will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation.”