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Fed attacks inflation with another big hike and expects more

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WASHINGTON (AP) — Intensifying its fight against high inflation, the Federal Reserve raised its key interest rate Wednesday by a substantial three-quarters of a point for a third straight time and signaled more large rate hikes to come.

The Fed’s move boosted its benchmark short-term rate, which affects many consumer and business loans, to a range of 3% to 3.25%, the highest level since early 2008.

The officials also forecast that they will further raise their benchmark rate to roughly 4.4% by year's end, a full percentage point higher than they had forecast as recently as June. And they expect to raise the rate further next year, to about 4.6%. That would be the highest level since 2007.

On Wall Street, stock prices fell and bond yields rose in response to the Fed’s projection of further steep rate hikes ahead.

The central bank's action Wednesday followed a government report last week that showed high costs spreading more broadly through the economy, with price spikes for rents and other services worsening even though some previous drivers of inflation, such as gas prices, have eased. By raising borrowing rates, the Fed makes it costlier to take out a mortgage or an auto or business loan. Consumers and businesses then presumably borrow and spend less, cooling the economy and slowing inflation.

Fed officials now see the economy expanding just 0.2% this year, sharply lower than its forecast of 1.7% growth just three months ago. And it expects sluggish growth below 2% from 2023 through 2025.

And even with the steep rate hikes the Fed foresees, it still expects core inflation — which excludes the volatile food and gas categories — to be 3.1% at the end of next year, well above its 2% target.

Chair Jerome Powell acknowledged in a speech last month that the Fed’s moves will “bring some pain” to households and businesses. And he added that the central bank’s commitment to bringing inflation back down to its 2% target was “unconditional.”

Falling gas prices have slightly lowered headline inflation, which was a still-painful 8.3% in August compared with a year earlier. 

The economy hasn’t seen rates as high as the Fed is projecting since before the 2008 financial crisis. Last week, the average fixed mortgage rate topped 6%, its highest point in 14 years. Credit card borrowing costs have reached their highest level since 1996, according to Bankrate.com.

Inflation now appears increasingly fueled by higher wages and by consumers’ steady desire to spend and less by the supply shortages that had bedeviled the economy during the pandemic recession. 

Some economists are beginning to express concern that the Fed’s rapid rate hikes -- the fastest since the early 1980s -- will cause more economic damage than necessary to tame inflation. Mike Konczal, an economist at the Roosevelt Institute, noted that the economy is already slowing and that wage increases – a key driver of inflation -- are levelling off and by some measures even declining a bit.

Surveys also show that Americans are expecting inflation to ease significantly over the next five years. That is an important trend because inflation expectations can become self-fulfilling: If people expect inflation to ease, some will feel less pressure to accelerate their purchases. Less spending would then help moderate price increases.

Konczal said there is a case to be made for the Fed to slow its rate hikes over the next two meetings.

“Given the cooling that’s coming,” he said, “you don’t want to rush into this.”

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