Powell: Fed sped up rate hikes after alarming May inflation surge

The head of the Federal Reserve said Wednesday the central bank broke from plans to hike rates at a slightly slower pace this month after late-breaking inflation data alarmed top officials.

The Federal Open Market Committee, the panel of Fed leaders responsible for setting monetary policy, hiked its baseline interest range Wednesday by 0.75 percentage points. The decision came after Fed leaders — including Chairman Jerome Powell — signaled for weeks that the Fed would hike rates by 0.5 percentage points this month.

The Fed tries to avoid breaking from so-called forward guidance, the comments Fed officials make to prepare financial markets for major decisions, in times of uncertainty. But Powell said Wednesday the Fed pivoted toward a higher rate hike after both inflation and inflation expectations rose in May.

“When I offered that guidance at the last meeting, I did say it was subject to the economy performing about in line with expectations,” Powell said during a Wednesday press conference. 

Powell said after the Fed’s last rate hike in May — an increase of 0.5 percentage points — that identical hikes were likely on the way in June and July if the economy held up as Fed officials expected. But the release of surprisingly high inflation data on Friday and subsequent polls of where consumers expected inflation to end up convinced Fed officials to hike rates faster.

“Since then, inflation has again surprised to the upside, some indicators of inflation expectations have risen and inflation projections for this year have been revised up notably. In response to these developments, the committee decided on a larger increase in the target range at today’s meeting.”

The Labor Department announced Friday that the consumer price index (CPI), a closely watched gauge of inflation, rose 1 percent in May alone and 8.6 percent over the past 12 months. Experts were concerned not only by how high prices rose, but also by how many goods and services saw rapid price growth in May.

Powell cited the stunning increase in the CPI and rising inflation expectations tracked by Fed surveys as a wake-up call for Fed officials, who thought inflation would be plateauing by now.

“We’ve been expecting progress and we didn’t get that. We got kind of the opposite,” Powell said, noting the U.S. was far from alone in the fight against inflation.

“All over the world we’re seeing these effects, and we’re seeing them here.”

Inflation has risen somewhat steadily since spring 2021 as the U.S. economy accelerated into a rapid rebound from the coronavirus-induced recession. While the U.S. labor market is historically strong and consumer spending has been resilient, inflation has hit its highest annual levels in more than 40 years, running far higher and for longer than many economists anticipated.

As the Fed raises interest rates, demand for goods and services will likely fall as consumers and businesses face higher borrowing costs. Lower demand should theoretically force firms to stop raising prices as they struggle to sell their goods and services.

Fed officials expect to hike interest rates another 2 percentage points by the end of the year to a midpoint of 3.4 percent. Fed interest rates have not been that high since the lead-up to the 2007-08 financial crisis and recession, but could end up even higher if inflation pressures persist.

“With inflation at 40-year highs, we think that policy is going to need to be restrictive, and we don’t know how restrictive,” Powell said. He made clear the bank would raise interest rates high enough to restrain the economy, but said the Fed is still attempting to curb inflation without causing a recession.

“There are pathways to do it, but those pathways have become much more challenging due to factors beyond our control,” Powell said.

Higher Fed interest rates work mainly by giving consumers and businesses less money to spend on goods and services. Interest rate hikes also tend to reduce stock market gains and home prices, which could force wealthier consumers to pull back spending even if they can handle the higher cost of living.

But Fed rate hikes only cover some of the forces driving inflation higher. While the Fed can help tamp down demand, higher interest rates do nothing to increase the supply of oil, wheat, fertilizer and other crucial commodities cut off by the war in Ukraine and economic sanctions imposed on Russia. Rate hikes will also do nothing to end severe COVID-19 lockdowns in China, which have caused serious manufacturing snarls, shipping delays and other inflationary supply chain problems.

“Gas prices are at all-time highs. That’s not something we can do something about,” Powell explained.

The Fed has historically tried to ignore short-term supply shocks when setting interest rates to avoid raising borrowing costs higher than the economy can handle. But Powell said the Fed still needed to lower inflation by any means necessary to avoid consumers and businesses losing faith in the bank’s ability to bring it down.

“The environment has become more difficult in the past four or five months and hence the need for the policy actions we took today,” Powell said.