The Federal Reserve raised interest rates again by half a percentage point on Wednesday. Though it decreased the intensity of the hike compared to the last four increases, Fed chairman Jerome Powell indicated that the central bank isn't done with its crusade on inflation yet.
"50 basis points is still a historically large increase, and we still have some ways to go," Powell said at Wednesday's press briefing. "The most important question now is no longer the speed, but how high to raise rates. ... Today, we have an assessment that we're not at a restrictive enough stance, even with today's move."
Over the last year the Federal Reserve has been working to temper rising prices. From groceries to gas, inflation has been squeezing Americans over the last 12 months. In response, the Fed has remained aggressive in raising interest rates, its top tactic to try to lower rising prices. With inflation finally showing signs of cooling off, the Fed is slowing down the rollout of its rate hikes. That said, Powell indicated that the bank isn't done hiking rates, but will simply move to a slower pace.
Rate hikes are the Fed's main countermeasure against inflation. Historically, when interest rates rise, the high cost of borrowing helps to stall the economy, with fewer consumers taking on new credit accounts. This in turn helps to lower prices. But the current inflation we're experiencing is a little different than in decades past. Today, inflation remains high for many reasons, including the war in Ukraine, pandemic demand challenges and the supply chain's struggle to keep pace. Despite multiple rate increases, the Fed has not yet been able to get inflation under control.
Many worry that further increases to the cost of borrowing money could contract the economy too much,sending us into a recession: a shrinking, rather than growing, economy. The Fed acknowledges the adverse effects and potential risks of this restrictive monetary policy.
While a recession would cause pain to the economy and American workers, the Fed has indicated that allowing inflation to linger for too long poses a larger threat. Here's everything you need to know about record high inflation, rate hikes and what's next for the economy.
What's going on with inflation?
Inflation has been high throughout 2022, reaching a record-high of 9.1% year-over-year in June. Since then, the rate of inflation has dipped slightly overall -- in October, inflation stood at 7.7% over the previous year, according to the Bureau of Labor Statistics. High inflation levels have stemmed primarily from an increase in gas, food and housing prices. While the pace of inflation is slowing, prices are still rising across the board, whether you're talking about groceries or housing.
During periods of high inflation, your dollar has less purchasing power, making everything you buy more expensive, even though you're likely not getting paid more. In fact, more Americans are living paycheck to paycheck, and wages aren't keeping up with inflation rates.
Why is inflation still so high?
Much of what we're seeing in the economy right now can be attributed to the pandemic. In March 2020, the onset of the COVID-19 pandemic caused the US economy to shut down. Millions of employees were laid off, many businesses had to close their doors and the global supply chain was abruptly put on pause. This caused the flow of goods produced and manufactured abroad and shipped to the US to cease for at least two weeks, and in many cases, for months, according to Pete Earle, an economist at the American Institute for Economic Research.
But the reduction in supply was met with increased demand as Americans started purchasing durable goods to replace the services they used prior to the pandemic, said Josh Bivens, director of research at the Economic Policy Institute. "The pandemic put distortions on both the demand and supply side of the US economy," Bivens said.
Though the immediate impacts of COVID-19 on the US economy are easing, labor disruptions and supply-and-demand imbalances persist, including shortages in microchips, steel, equipment and other goods, causing ongoing slowdowns in manufacturing and construction. Unanticipated shocks to the global economy have made things worse -- particularly subsequent COVID-19 variants, lockdowns in China (which restrict the availability of goods in the US) and Russia's war on Ukraine (which is affecting gas and food prices), according to the World Bank.
Some lawmakers have also accused corporations of seizing on inflation as an excuse to increase prices more than necessary, a form of price gouging.
Why does the Federal Reserve keep raising rates?
With inflation hitting record highs, the Fed is under a great deal of pressure from policymakers and consumers to get the situation under control. One of the Fed's primary objectives is to promote price stability and maintain inflation at a rate of 2%.
By raising interest rates, the Fed aims to slow down the economy by making borrowing more expensive. In turn, consumers, investors and businesses pause on making investments and purchases with credit, which leads to reduced economic demand, theoretically reeling in prices and balancing the scales of supply and demand.
The Fed raised the federal funds rate by a quarter of a percentage point in March, followed by a half of a percentage point in May. It then raised rates by three-quarters of a percentage point in June, July, September and November. Today, it raised rates by half a percentage point.
The federal funds rate, which now sits at a range of 4.25% to 4.50%, is the interest rate that banks charge each other for borrowing and lending. And there's a trickle-down effect: When it costs banks more to borrow from one another, they offset it by raising rates on their consumer loan products. That's how the Fed effectively drives up interest rates in the US economy.
However, hiking interest rates can only reduce inflationary pressures so much, especially when the current factors are largely on the supply side -- and are worldwide. A growing number of economists say that the situation is more complicated to get under control, and that the Fed's monetary policy alone is not enough.
Can we avoid a recession at this point?
A recession is seeming more likely, and Powell himself has said it's likely we're headed towards a period of "below-trend growth." However, it's still unclear how these policy moves will broadly affect prices and wages.
Officially, the National Bureau of Economic Research calls a recession. By their definition, a recession is a "significant decline in economic activity that is spread across the economy and lasts more than a few months." That means a declining gross domestic product, or GDP, alongside diminishing production and retail sales, as well as shrinking incomes and lower employment. The first quarters of 2022 match this definition, but no official call has been made yet.
Will the unemployment rate go up?
The unemployment rate in the US is expected to rise over the next year. Right now, unemployment sits at 3.5%,according to the BLS, but the Fed anticipates unemployment to hit 4.4% in 2023, as noted in itsSummary of Economic Projections.
Historically, pushing rates too quickly can reduce consumer demand too much and unduly stifle economic growth, leading businesses to lay off workers or stop hiring. That often drives up unemployment, leading to another problem for the Fed, as it's also tasked with maintaining maximum employment.
In a general sense, inflation and unemployment have an inverse relationship. When more people are working, they have the means to spend, leading to an increase in demand and elevated prices. However, when inflation is low, joblessness tends to be higher. But with prices remaining sky-high, many investors are increasingly worried about a coming period ofstagflation, the toxic combination of slow economic growth with high unemployment and inflation.
Here's what higher interest rates mean for you
Raising interest rates means buying a car or a home is more expensive, since you'll pay more in interest. Higher rates could make it more expensive to refinance your mortgage or student loans. Moreover, the Fed hikes will drive up interest rates on credit cards, meaning that your debt on outstanding balances will go up.
Securities and crypto markets can also be negatively impacted by the Fed's decisions to raise rates. When interest rates go up, money is more expensive to borrow, leading to less liquidity in both the crypto and stock markets. Investor psychology can also cause markets to slide, as cautious investors may move their money out of stocks or crypto into more conservative investments, such as government bonds.
On the flip side, rising interest rates could mean a slightly better return on your savings accounts. Interest rates on savings deposits are directly affected by the federal funds rate. Several banks have already increased annual percentage yields, or APYs, on their savings accounts and certificates of depositin the wake of the Fed's rate hikes.
It Could Trigger a Recession and a Rise in Unemployment
The risks are high, and timing is everything. If the Fed raises rates too high and too quickly, it could cool demand so much that the economy tips into a recession. Higher interest rates make debt costlier and borrowing harder — for both consumers and businesses.
How Do Interest Rates Affect Inflation? In general, rising interest rates curb inflation while declining interest rates tend to speed inflation. When interest rates decline, consumers spend more as the cost of goods and services is cheaper because financing is cheaper.How does Fed interest rate hike affect inflation? ›
Even so, interest rate hikes are known as the central bank's one major tool to lower inflation, which it does by raising the cost of borrowing money to curb the demand for goods and services. Economists won't know until later if the Fed's moves were successful or not.Does the Fed raise interest rates to slow inflation? ›
How does raising interest rates tame surging inflation? In 2022, the Federal Reserve raised its key federal funds rate seven times — something it hasn't done as aggressively since the 1980s. The central bank hopes that by doing so, it can slow down the economy enough to moderate price growth.How high will interest rates go in 2023? ›
The Federal Reserve's projections released after their December meeting showed that in 2023 the bank expects the FFR to average around 5.1 percent.Will bank interest rates go up if Fed raises rates? ›
A Fed rate increase doesn't instantly change the rates your bank offers, but it can lead to an increase for some accounts. In a higher-rate environment, banks may start raising rates on savings accounts to attract new customers. This puts competitive pressure on other institutions to increase their rates.What assets do well with rising interest rates? ›
- Banks and other financial institutions. As rates rise, banks can charge higher rates for their mortgages, while moving up the price they pay for deposits much less. ...
- Value stocks. ...
- Dividend stocks. ...
- The S&P 500 index. ...
- Short-term government bonds.
But a steady decline in rates the past two months have convinced more economists that rates could level off through early 2023, barring an economic downturn. The average 30-year, fixed-rate mortgage was 6.15% for the week ending January 19, down from 6.33% in the previous week, according to Freddie Mac.Who benefits from inflation? ›
1. Collectors. Historically, collectibles like fine art, wine, or baseball cards can benefit from inflationary periods as the dollar loses purchasing power. During high inflation, investors often turn to hard assets that are more likely to retain their value through market volatility.Will interest rates go down again in 2024? ›
Scotiabank forecast the UK's key interest rate to rise to 4.25% in 2023, and decline to 3.25% in 2024.
For the Fed's future meeting in March of 2023, the majority of investors expect the Fed to raise the federal funds rate to inside a range of 4.75% to 5%. But more than 33% of market participants (the largest portion) expect the federal funds rate to be back inside a range of 4.5% to 4.75% by November.How long will interest rates stay high? ›
However, many industry experts believe within 18 to 24 months rates will be back to a more 'palatable' level. Somewhere like 2.5% to 3.5% for example. We can't expect rates to reduce as low as what we have been seeing in recent years, which in the industry we refer to as 'covid low' rates.Who makes more money when interest rates go up? ›
Financial services, which can include banks, insurance firms and brokerage companies, is one of the key industries that benefits from a sharp rise in interest rates. For example, profit margins can increase during this time, especially with banks. With higher rates, banks can charge higher rates on consumer loans.Which bank gives 7% interest on savings account? ›
Do Banks Offer 7% Interest On Savings Accounts? 7% interest isn't something banks offer in the US, but one credit union, Landmark CU, pays 7.50% interest, though there are major requirements and stipulations.What are the best assets to own during high inflation? ›
- TIPS. TIPS stands for Treasury Inflation-Protected Securities. ...
- Cash. Cash is often overlooked as an inflation hedge, says Arnott. ...
- Short-term bonds. ...
- Stocks. ...
- Real estate. ...
- Gold. ...
- Commodities. ...
Sectors that are also very vulnerable to the rising rates are broadcasting and media, technology, and telecommunications. Those sectors are very leveraged, and those levels of indebtedness, in combination with the rising interest rate environment, will continue to increase their cost of borrowing.Do rising interest rates hurt homeowners? ›
When the economy is strong, interest rates tend to rise along with growth. Higher interest rates, however, translate into higher mortgage loan costs. Rising rates make homes more expensive for buyers, thereby reducing the demand for home purchases.What will interest rates do in the next 5 years? ›
In its fiscal forecast, published in November 2022, the OBR predicted that the Bank Rate would rise from 1.6% in Quarter 3 2022 to 4.8% in Quarter 3 2023 and 4.5% in Quarter 3 2024.Should I lock in my interest rate? ›
Most borrowers are attracted to the certainty a fixed-rate home-loan product offers, especially those who are budget-conscious. In fact, it is advisable for first-home buyers to take on a fixed-rate loan to be able to organize their budgets easily and to stay on top of their repayments.Will interest rates go back down in the next 5 years? ›
"Mortgage rates will decline slightly but end up higher overall across 2023. Expect interest rates to continue to rise and mortgage rates to reach their peak over the summer above 10%."
This happens because inflation hurts the lower incomes but actually enriches the higher incomes. Imagine a family making $30,000 with no assets seeing a 5 percent annual inflation rate. They see their expense rise by 5 percent (losing $1,800 in buying power due to the inflation) and have no way of making it up.Who is most hurt by inflation? ›
In 8 out of 17 countries, lower-income groups whose consumption basket is mainly composed of essential goods are most affected by the increase in prices. Poorest households suffered a rise in prices 2 to 5 percentage points higher than the wealthiest households.Who loses from inflation Who wins from inflation? ›
Lenders are hurt by unanticipated inflation because the money they get paid back has less purchasing power than the money they loaned out. Borrowers benefit from unanticipated inflation because the money they pay back is worth less than the money they borrowed.Is the Fed going to raise interest rates again in 2022? ›
For more information, see How We Make Money. The Federal Reserve just raised the target federal funds rate range to 4.25% – 4.50%. The 50 basis point increase pushes the rate to the highest it's been since December 2007. It also marks the seventh consecutive rate hike for 2022.Will the feds drop interest rates again? ›
Most economists say the Fed will likely stop raising interest rates at some point in 2023, but “where” rates peak — a level known as the “terminal” rate — is actually more important than “when.” While the Fed is starting to raise rates in smaller amounts, what's clear is the Fed isn't done raising rates yet.How many rate hikes are expected in 2023? ›
Even if the Fed's highest forecasts come to fruition, it shows that, at most, only 1.25 percentage points of rate hikes are on the table for 2023. That's nowhere near the 4.25 percentage points of tightening Fed officials approved in 2022 alone.Will Fed raise rates again in 2023? ›
However, the Fed sees broadly sees one or two more hikes than the market does in 2023 currently taking rates materially over 5%, whereas markets aren't sure rates will exceed 5%. Optimistically, that may be because inflation data will trend better than the Fed currently anticipates.Will Fed lower rates in 2023? ›
Fed Expects No Interest Rate Cuts In 2023: One Official Warns Of 'Costly Error' If Central Bank Backs Down Too Soon.How high will interest rates go in 2024? ›
The Fed sees its rate peaking in a target range of 5-5.25%. Forecasts for the Fed's peak interest rate range from a low of 4.75% to a high of 6.25%. The Fed's lowest forecast for interest rates was 4.9%, while its highest was 5.6%. 62% say the Fed probably won't cut interest rates until 2024.What will interest rates look like in 2024? ›
The base rate will then fall to three per cent the year after due to a weakened housing market. Additionally, a steady fall in inflation will allow the central bank to make cuts to the base rate in 2024, with reductions which will be sharper than projected.
Most major forecasting organizations including Mortgage Bankers Association, Freddie Mac, and National Association of Realtors (NAR) believe rates will steadily decrease through 2023 and that trend will continue into 2024.