Will the Fed continue to raise interest rates? Here’s what the latest inflation statistics tell us

This story is part Recession Assistance ServiceCNET’s coverage of how to make smart money moves in an uncertain economy.

What is happening

Inflation remained unchanged in July. If prices remain stable or decline throughout August, the Fed could slow the rollout of interest rate hikes.

why is it important

If the Fed continues to raise interest rates, there will be consequences – most likely higher unemployment and higher interest rates for mortgages, credit cards and loans.

What this means for you

Soaring consumer prices, falling inventories, rising borrowing costs and the threat of layoffs could prove especially devastating for low- and middle-income Americans.

The Consumer price index have shown that inflation slowed in July, although prices remain at record highs, with significant increases in food and housing over the past month. The Federal Reserve has been on a crusade to calm rising prices since late last year, but it’s too early to tell whether, in light of July’s slowing inflation, we’re seeing the fruits of its labor.

That of the Federal Reserve next meeting is in September, and Fed Chairman Jerome Powell has said he expects further rate hikes throughout the year. But, depending on the pace of inflation over the next month, that could change. If inflation improves significantly in August, the Fed could slow the rollout of interest rate hikes – or at least raise interest rates by a smaller amount, compared to the previous two hikes .

Raising interest rates is the main action the Fed can take to try to counter high inflation. When it costs more to borrow – as it does credit card, mortgages and other loans — consumers have less purchasing power and will buy fewer items, decreasing the “demand” side of the supply-demand equation, theoretically contributing to lower prices.

Experts fear that further increases in the cost of borrowing could contract the economy too much, send us into a recession: an economy in decline rather than growth. The Fed recognizes the perverse effects of this restrictive monetary policy.

“We are very attentive to inflation risks and committed to taking the necessary steps to bring inflation back to our longer-term target of 2%,” Powell said during the press conference. July press conference. “This process will likely involve a period of below-trend economic growth and some easing of labor market conditions. But such outcomes are likely necessary to restore price stability and set the stage for maximum employment and stable prices. long-term. “

As rates rise and inflation continues to rise, you may be wondering how we got here. We’ll break down everything you need to know about what’s causing record high inflation and how the Fed hopes to drive levels down.

What’s going on with inflation?

In July, inflation jumped to 8.5% from a year earlier, down slightly from 9.1% in June, according to the Bureau of Labor Statistics. Gas prices fell significantly by 7.7% in July, but this was offset by higher food and housing prices. Food rose 1.1% last month, the latest in several months of price increases.

During times of high inflation, your dollar has less purchasing power, making everything you buy more expensive, even though you probably aren’t getting paid more. In reality, more Americans are living paycheck to paycheckand wages are not keeping up with inflation rates.

Why is inflation so high right now?

In short, much of this can be attributed to the pandemic. In March 2020, the outbreak of COVID-19 caused the US economy to shut down. Millions of employees were laid off, many businesses had to shut down, and the global supply chain was abruptly put on hold. According to Pete Earle, an economist at the American Institute for Economic Research.

But the reduction in supply has been accompanied by increased demand as Americans have started to buy durable goods to replace the services they used before the pandemic, said Josh Bivens, director of research at the Economic Policy Institute. “The pandemic has created distortions on both the demand and supply side of the U.S. economy,” Bivens said.

Although the immediate impacts of COVID-19 on the U.S. economy are easing, labor disruptions and supply and demand imbalances persist, including shortages of microchips, steel, equipment, and other goods, leading to continued slowdowns in manufacturing and construction. Unforeseen shocks to the global economy have made matters worse – particularly later variants of COVID-19, lockdowns in China (which limit the availability of goods in the United States) and war in Ukraine (which affects prices of gas and foodstuffs), according to the World Bank.

Powell confirmed the World Bank’s findings at the June Fed meeting, calling these external factors difficult because they are out of central bank control.

Some lawmakers have also accused companies of using inflation as an excuse to raise prices more than necessary, a form of abusive price.

Why is the Federal Reserve raising rates?

As inflation hits record highs, the Fed is under heavy pressure from policymakers and consumers to get the situation under control. One of the main objectives of the Fed is to promote price stability and to keep 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 stop to make investments and purchases on credit, leading to a reduction in economic demand, theoretically lower prices and a balance between supply and demand. .

The Fed raised the federal funds rate by a quarter of a percentage point in March, followed by half a percentage point in May and three-quarters of a percentage point in mid-June. In July, the Fed raised interest rates another three-quarters of a percentage point.

The federal funds rate is the interest rate that banks charge each other to borrow and lend. And there’s a ripple effect: when it costs banks more to borrow from each other, they make up for it by raising the rates on their consumer loan products. This is how the Fed effectively raises interest rates in the US economy.

The fed funds rate is now in a range of 2.25% to 2.5%. But the Fed thinks that needs to rise significantly to see progress on inflation, likely in the 3.5% to 4% range, according to Powell. The Fed’s latest estimate is that by the end of this year, the fed funds rate will be in the range of 3.25% to 3.50%.

However, rising interest rates can only reduce inflationary pressures to a certain extent, especially when the current factors are largely on the supply side – and are global. A growing number of economists say that the situation is more complicated to control and that the Fed’s monetary policy alone is not enough.

Could rising interest rates trigger a recession?

We cannot yet determine how these policy measures will affect prices and wages overall. But with more rate hikes expected this year, there are concerns that the Fed could overreact by raising rates too aggressively, which could trigger a more painful economic downturn or create a recession.

The National Bureau of Economic Research, which has not yet officially determined whether the United States is in a recession, defines a recession as “a significant decline in economic activity that spreads throughout the economy and lasts more than a few months”. This means a decline in gross domestic product, or GDP, alongside falling production and retail sales, as well as falling incomes and falling employment.

Rising rates too quickly could reduce consumer demand too much and unduly stifle economic growth, leading businesses to lay off workers or stop hiring. This would drive up unemployment, which would cause another problem for the Fed, as it is also responsible for maintaining maximum employment.

Generally speaking, inflation and unemployment have an inverse relationship. When more people work, they can afford to spend, leading to increased demand and high prices. However, when inflation is low, unemployment tends to be higher. But with prices that remain exorbitant, many investors are increasingly worried about an upcoming period of stagflation — the toxic combination of slow economic growth with high unemployment and inflation.

Here’s what higher interest rates mean to you

Over the past two years, interest rates had hit historic lows, in part because the Fed cut rates in 2020 to keep the US economy afloat in the face of lockdowns. The Fed has kept interest rates near zero, a decision taken only once before, during the 2008 financial crisis.

For the average consumer, a rise in interest rates means to buy a car or one the house will become more expensive, since you will pay more interest. Higher rates could make it more expensive refinance your mortgage Where student loans. In addition, Fed hikes will drive up interest rates on credit cardwhich means your debt on outstanding balances will increase.

Securities and crypto markets could also be negatively affected by Fed decisions to raise rates. When interest rates rise, money is more expensive to borrow, reducing liquidity in the crypto and equity markets. Investor psychology can also cause markets to fall, as cautious investors may shift their money from stocks or crypto to more conservative investments, such as government bonds.

On the other hand, 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 the annual percentage yields, or APY, on their savings accounts and certificates of deposit following the Fed’s rate hikes.

We will keep you updated on the changing economic situation as it evolves.

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