The Federal Reserve approved Wednesday its first increase in interest rates for more than three decades. This is an incremental step to combat spiraling inflation and not torpedo economic growth.

The Federal Open Market Committee, which is responsible for determining policy, said that rates will be raised by 25%, or 25 basis point. It had kept its benchmark rate at zero during the Covid pandemic.

This will increase the current rate to 0.25%-0.5%. This will result in a rise in the prime rate, which immediately raises financing costs for consumer credit and borrowing.

The committee also estimated rate increases at six of its remaining meetings for this year. This points to a consensus funds rate in the region of 1.9% by the year’s end. In 2023, the committee expects to see three additional rate hikes and no increase in the year following.

One dissenter was not present when the rate hike was approved. James Bullard of St. Louis Fed requested a 50-basis point increase.

Last December 2018, the committee raised rates. Then, it had to reverse its decision and cut in July 2018.

The FOMC stated that it “anticipates” continued increases in its target range. Referring to the Fed’s $9 trillion-plus balance sheet made up mainly from Treasurys and Mortgage-backed Securities, it stated that the Statement said “In addition, The Committee expects the Committee to start reducing its Treasury securities holdings and agency.”
A meeting will be held to discuss debt and agency mortgage-backed security.

The rate rise was accompanied by an increase in the committee’s outlook. They also adjusted their outlook on expected rate increases through the end year.

In the early stages of the pandemic, the central bank had reduced its federal funds rates to stop a shutdown that would have crippled America’s economy. This shut down resulted in 22 million Americans being sent to unemployment.

Many factors combine to make the Fed tighten its grip on inflation. Policymakers rejected this condition last year, calling it “transitory”. Before giving in, however. In the two-months that have passed, Fed officials strongly suggested interest rate rises. Investors will now need to determine how rapid and how many.

Current price rises, which are at the fastest pace of inflation in over 40 years, have been fueled by demand. Supply chains, though still clogged, remain more obstructed than they were during pandemic-era peak levels. Unprecedented levels of fiscal and monetary stimulus – more than $10 trillion worth – have coincided with the inflation surge. Even though oil prices have been declining in recent weeks, the Ukraine conflict has coincided avec a significant spike in fuel costs.

CME Group data shows that markets were pricing in an equivalent to seven increases of 0.25% for this year before the FOMC meeting. The issue of whether the Fed will raise 50 basis point in May was a matter for debate between traders and CME Group data. Some officials suggested that this could occur if inflation pressures remain.

According to the Consumer Price Index, prices are rising 7.9% annually. This index measures an extensive range of goods and services. The biggest problem has been energy, with gasoline prices rising 38% over the past 12-months.

However, the price pressures are not limited to groceries and gas.

After plummeting during the initial days of the pandemics, clothes prices have increased 6.6% in the last year. Car repair and maintenance costs have gone up by 6.3% while airfares have shot 12.7%. The CPI’s rent of shelter, which accounts for nearly one third of it, has been rising rapidly in recent months. They are currently up 4.8% annually.

All these cost increases have left behind the Fed’s 2% inflation target.

In September 2020, the Fed approved a new method of fighting inflation. It would allow it to run faster in pursuit of an inclusive and full employment goal. This includes a broad range across race, gender, and wealth. The change of approach led to more dangerous inflation in the United States than ever since the Arab oil embargo. This was in addition to an inflation rate that reached nearly 15% at its peak in the 1980s.

In those days the Fed led by Paul Volcker had to increase interest rates so high that they caused a recession. That is what central bankers want to avoid. In those days, the funds rate was above 19%.