Fed set for another big rate hike with economy on knife-edge

WASHINGTON (AFP) – US central bankers face an increasingly difficult balancing act as they struggle to douse scorching inflation while still keeping the economy growing, though they have made it clear they are willing to risk a recession.

But with war still raging in Ukraine and Covid-19 causing ongoing issues in Asia, avoiding an economic downturn will require luck and depend on many factors outside the United States Federal Reserve’s control.

As American families struggle to make ends meet amid surging prices for gas, food and housing, Fed officials have made clear that fighting inflation is their top priority even if that means inflicting pain.

The Fed will hold its two-day policy meeting on July 26 to 27, when it is expected to hike the benchmark borrowing rate by another three-quarters of a percentage point in its aggressive campaign to cool demand and ease price pressures.

Despite a healthy job market with near-record low unemployment, workers are seeing their wage gains overwhelmed by consumer prices that rose by a new 40-year high of 9.1 per cent in June.

Slowing the economy is likely to cause more job losses, but policymakers want to avoid at all costs the greater pain of a price spiral that becomes entrenched or spins out of control.

Treasury Secretary Janet Yellen, herself a former Fed chief, has previously warned that such a soft landing will require good luck. On Sunday (July 24), she stressed again that while “growth is slowing”, the data does not necessarily point to a recession.

“I am not saying that we will definitely avoid a recession, but I think there is a path that keeps the labour market strong and brings inflation down,” she told NBC.

Aggressive rate hikes

Former Fed vice-chair Donald Kohn told AFP it was a “very complicated, multi-dimensional issue”, especially due to the ongoing supply chain uncertainty.

After flooding the world’s largest economy with support during the pandemic – zero interest rates and a steady stream of liquidity into the financial system – Fed policymakers were congratulating themselves on how quickly the economy recovered, regaining millions of jobs in a matter of months.

But they were caught flat-footed by the rapid run-up in prices as Americans, flush with cash due to massive government aid, went on a spending spree, buying up cars, houses and other goods at a time when the global supply chain was still bogged down by pandemic lockdowns that continue in China.

The Fed finally began lift-off – taking the policy interest rate off zero – in March, starting with a 25-basis point increase, followed by 50 in May and 75 in June.

Higher lending costs make it more expensive to borrow funds to buy cars and homes or expand businesses, which should cool demand, while also making it more attractive to save rather than spend.

Fed chair Jerome Powell last month said the policy-setting Federal Open Market Committee would consider a hike of either 50 or 75 basis points at the July meeting, and most economists expect a repeat of the June three-quarter-point increase.

Fed governor Christopher Waller recently floated the idea of a mammoth 100-basis point hike, which would be the first since the US central bank started using the federal funds rate for policy in the early 1990s.