The Federal Reserve hints it may hike rates twice in 2023 as inflation hits decade-plus highs

Federal Reserve
  • The Federal Reserve’s latest economic forecasts suggest two rate hikes could arrive in 2023.
  • The Fed previously indicated that rate hikes wouldn’t arrive until after 2023.
  • The new estimates come after strong demand and various bottlenecks fueled stronger inflation through the spring.
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New economic projections from the Federal Open Market Committee suggest the central bank will raise its benchmark interest rate two times in 2023, pulling forward such a move as inflation surges throughout the US economy.

The central bank previously placed its first forecasted rate hikes past 2023, signaling it was willing to let inflation run hot to let the US economy recover faster. Yet the median projections included in its latest set of forecasts see enough FOMC members supporting dual rate hikes in 2023.

FOMC DOTS

Separately, the FOMC elected on Wednesday to hold rates near zero and continue purchasing at least $120 billion in Treasurys and mortgage-backed securities each month. Changes to the current stance won’t come until “substantial further progress” has been made toward the Fed’s goals of maximum employment and above-2% inflation, according to a statement.

The rate projections mark a significant update to when the central bank will seek policy normalization. The Fed’s benchmark rate affects borrowing costs throughout the US economy, from car loans to credit card rates. While low rates historically encourage borrowing, they can give way stronger inflation.

Policymakers slashed rates to historic lows at the start of the pandemic to stimulate economic activity. Vaccinations and reopening have since revived much of the US economy. Consumer spending rebounded through the spring, and gross domestic product is set to stage a complete recovery by the end of the second quarter.

The Fed’s latest projections are also the first to arrive after reopening and a wave of pent-up demand drove inflation markedly higher through the spring. Most recently, the Consumer Price Index showed prices climbing 0.6% in May, beating the median estimate for a 0.4% estimate. The inflation gauge rose by 5% on a year-over-year basis, marking the strongest rate of price growth since 2008.

Fed Chair Jerome Powell has repeatedly indicated that much of the stronger inflation is merely “transitory” and will give way as the economy settles into a new normal. The updated rate-hike projections, however, signal FOMC members could see inflation posing a larger risk and warranting an earlier pullback from ultra-easy monetary policy.

Powell hit back against claims that the updated dot plot would translate to real rate hikes. The forecasts should “be taken with a big grain of salt” and “are not a great forecaster of future rate moves,” he said in a press conference.

Brighter outlook at the Fed, negative reaction from stocks

The FOMC also updated its forecasts for GDP and unemployment to reflect a slightly more positive outlook. Officials now see economic output growing 7% in 2021, up from the March estimate of 6.5% growth. The estimate for 2022 growth held at 3.3%, and the estimate for 2023 growth rose to 2.4% from 2.2%.

Committee members forecast the unemployment rate will slide to 4.5% this year, the same level it forecasted in March. Its 2022 estimate dipped to 3.8% from 3.9%.

Stocks slightly extended earlier losses on the news, suggesting investors mostly anticipated such a shift in projections. It’s now up to Powell and other officials to ensure to investors that tightening won’t disrupt markets, said Seema Shah, chief strategist at Principal Global Investors.

“There will still be question marks about the timing of tapering but, overall, the dot plot shouldn’t unnerve the market too much, as long as Powell gets his communication on target,” she said.