Federal Reserve Raises Interest Rates

On Wednesday, the Federal Reserve made an announcement stating that it had raised its key interest rate by 0.25%, bringing it to 5.5%, the highest rate in over two decades. The primary aim behind this move is to combat the ongoing inflation in the U.S. economy.

Despite a 12-month decline in consumer prices, there was a 3% year-on-year increase in consumer prices in June. Although this is the lowest annual inflation rate seen in over two years, the Federal Reserve still considers it to be too high. The central bank is determined to bring inflation down to around 2%.

By increasing the interest rates, the Federal Reserve hopes to make borrowing and investing more expensive, which, in turn, would reduce the overall demand for goods, services, and labor in the economy. However, this effort risks pushing the economy toward a recession, depending on various factors. Federal Reserve Chair Jerome Powell has expressed his intention to avoid such an outcome despite no guarantees.

Following the interest rate announcement, Powell reassured that the central bank no longer expects a recession as a result of the rate increases. He even mentioned the possibility of further increasing the key interest rate.

Nonetheless, some analysts remain cautious about the potential challenges ahead. Inflation continues to remain stubbornly high, and the robust labor market might contribute to this persistently high inflation. To address this, the Federal Reserve aims to balance unemployment and inflation, with the current unemployment rate at a historically low 3.6%.

The strategy the Fed is employing involves reducing the overall number of job openings relative to the number of unemployed workers instead of directly causing massive job losses. The labor market is considered to be somewhat imbalanced, which can contribute to inflationary pressures.

Although the overall inflation rate has decreased, specific consumer-focused service categories have not seen much improvement. "Supercore" inflation, which excludes food, gas, and shelter prices, has remained at a 4% annual rate of increase since early 2021.

One reason for this is the significant demand for workers in certain industries, leading to higher wages. While higher wages are beneficial for workers and have outpaced inflation in the post-pandemic period, they also raise concerns for the Federal Reserve as they can be linked to higher inflation. Businesses tend to raise prices if they believe customers have more money to spend, creating a self-reinforcing loop between employment, income, and spending.

In light of these factors, analysts expect the Federal Reserve to remain focused on slowing down the job market to pave the way for a sustained return to the 2% inflation target.