The Federal Reserve is likely to discuss making its biggest interest rate increase since 1994 at its meeting this week, as a range of new data suggest that inflation is coming in hotter and proving more stubborn than policymakers had hoped.
Central bankers have been promising to be nimble as they fight inflation — a stance that will probably prompt them to at least discuss whether to raise interest rates by three-quarters of a percentage point on Wednesday, when officials are set to release both their decision and a fresh set of economic projections.
The Fed raised rates by half a percentage point in May and officials had suggested for weeks that a similar increase would be warranted at their meetings in June and July if data evolved as expected. But costs have not behaved as anticipated.
Instead, a report last week showed that inflation re-accelerated in May and is running at the fastest pace since 1981. Two separate measures of inflation expectations, one out last week and another released Monday, showed that consumers were beginning to anticipate notably faster price increases.
That is sure to increase the sense of unease at the Fed, which is trying to quash high inflation before it changes behavior and becomes a more permanent feature of the economic backdrop. Jerome H. Powell, the Fed chair, and other officials have repeatedly stressed the need to bring prices back down to a stable level to ensure a healthy economy. The string of worrying news has caused economists and investors alike to bet that the central bank will begin to raise interest rates at a more rapid clip to signal that it recognizes the problem and is making fighting inflation a priority.
“They’ve made it pretty clear that they want to prioritize price stability,” said Pooja Sriram, U.S. economist at Barclays. “If that is their plan, a more aggressive policy stance is what they need to be doing.”
Wall Street is bracing for interest rates to rise more than investors had anticipated just days ago, a reality that is sending stocks plummeting and causing other markets to bleed, including that for cryptocurrencies. Investors now expect rates to climb to a range of 2.5 to 2.75 percent as of the Fed’s September gathering from their current range of 0.75 to 1 percent.
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That suggests central bankers would need to make one three-quarter-point move over the course of its next three meetings. The Fed hasn’t made such a large increase since the early 1990s, and that 2.75 percent upper limit would be the highest the federal funds rate has been since the global financial crisis in 2008.
Such an abrupt policy path would have big implications for the economy. When the Fed lifts its policy interest rate, it filters through the economy to make borrowing of all kinds — including mortgage debt and business loans — more expensive. That slows down the housing market, keeps consumers from spending so much and cools off corporate expansions, weakening the labor market and broader economy. Slower demand can help price pressures to ease as fewer buyers compete for goods and services.
But interest rates are a blunt tool, making it difficult for the Fed to slow the economy with precision. Likewise, it is tough to predict how much conditions need to cool to bring inflation down convincingly. Supply issues tied to the pandemic could ease, allowing for a deceleration. But the war in Ukraine and China’s newly reimposed lockdowns meant to contain the coronavirus could keep prices elevated.
Households, economists and investors increasingly fear that the central bank will set off a recession, and anxiety about a coming downturn ricocheted through markets on Monday.
Stock indexes dropped sharply around the world throughout the day, and a bond-market signal that traders monitor closely now suggests that a downturn may be coming. The yield on the two-year Treasury note, a benchmark for borrowing costs, briefly rose above the 10-year yield on Monday. That so-called inverted yield curve, when it costs more to borrow for shorter periods than longer periods, typically does not happen in a healthy economy and is often taken as a sign of an impending recession.
While the economy is strong now, a slump that erases some of the recent solid progress in the job market would be bad news for President Biden, whose approval ratings have already swooned amid inflation’s rise.
Still, the White House has been sure to emphasize that the Fed is independent and that it will respect its ability to do what it deems necessary to bring inflation under control. Mr. Biden, in a recent opinion column, acknowledged that the nation was about to enter a transition period.
“The Federal Reserve has a primary responsibility to control inflation,” Mr. Biden wrote. He added that “past presidents have sought to influence its decisions inappropriately during periods of elevated inflation. I won’t do this.”
The Fed has a two-part mandate to achieve both stable prices and maximum employment. But officials have increasingly emphasized that a strong job market with runaway price increases is far from stable, and that getting inflation under control is a precondition for a truly healthy labor market.
Wrestling prices back under control has looked like an increasingly hairy challenge as wage growth remains strong, consumers continue to spend at a rapid clip and families begin to think that price increases might last. In the 1970s, economists believe, Americans began to expect faster inflation and demand bigger wage increases, setting off a chain reaction that fed on itself and pushed prices ever higher.
Paired with the possibility that uncontrollable shocks could continue to push prices up — for instance, the war in Ukraine is expected to continue elevating commodity costs — the latest developments have put the Fed in a tight position.
“We can’t allow a wage price spiral to happen, and we can’t allow inflation expectations to become unanchored,” Mr. Powell, the Fed chair, said during a news conference with reporters after the central bank’s May meeting. “It’s just something that we can’t allow to happen.”
The Fed has been in its pre-meeting blackout period, during which its officials do not give remarks on monetary policy, for several key data releases — including the latest hot inflation reading. That has left Wall Street guessing about whether its officials might contemplate speeding up the process.
But the central bank’s buzzwords for the year have been “nimble” and “humble,” terms Mr. Powell has emphasized repeatedly.
“This is when being nimble matters,” said Diane Swonk, chief economist at Grant Thornton. “A 75-basis-point move would underscore their commitment to avoid mistakes of the 1970s.”