The US Federal Reserve has raised interest rates for the first time in four years and is expected to increase them further over the course of the year, following a hawkish meeting this week.
A rise of 0.25 percentage points is consistent with other central banks such as the Bank of England, which hiked rates by 0.15 percentage points in December 2021 to 0.25%, before doubling them in January.
The Fed's target range is now 0.25 to 0.5%.
The updated dot plot – a chart released by the Fed to signal its intent for rates – showed there were likely to be an additional six hikes this year, and a 0.25 percentage point increase in each meeting for the remainder of 2022.
Silvia Dall'Angelo, senior economist at Federated Hermes, said: “In addition, the dot plot suggests that most [Federal Open Market Committee] FOMC participants now see a restrictive monetary policy stance as appropriate by the end of 2023.”
Hawkish expectations on rates were justified, she said, even though the economic picture has worsened. Growth in the US was adjusted down in the meeting, although economic activity is more stable than in other countries.
However, inflation is now expected to remain high throughout this year – a stark change from the ‘transient’ rhetoric of last year – as the recent surge in energy prices has meant there is little sign of overall price rises slowing in the near future.
“The Fed is well aware of the risk of a price-wage spiral: the longer inflation remains elevated, the higher the risk it becomes embedded via expectations and wage formation dynamics. And recent developments across inflation and labour market indicators already point to some emerging second-round effects,” Dall'Angelo said. According to the Fed, wage growth is at its highest level on record.
Hinesh Patel, portfolio manager at Quilter Investors, said it was notable the Fed had decided to raise rates despite the threats from Omicron, China’s regulatory crackdown and the war in Ukraine.
“None of these threats, however, are resolved by monetary policy and with the inflation shock reverberating around the system, the Fed needs to move back to normalcy, at least to build in some insurance for when easing will once again be required in the future,” he said.
“Even with the six further hikes priced in, monetary policy in our view remains loose, especially when looking at real rates.”
The manager added that markets are usually volatile in the lead-up to tightening, but “soon settle down”, suggesting investors should ride out any downward shocks.
Not everyone believed that the Fed would raise rates six times more this year, however. Charles Hepworth, investment director at GAM Investments, said: “With a slowing economy and worsening financial conditions, it’s highly unlikely that its projected trajectory will be delivered on.”
Dall'Angelo added that, as geopolitical uncertainty looms large, the Fed will likely continue to be reactive rather than proactive and that, while the Fed is sounding hawkish, “it is not a given that action will follow in short order”.
Gurpreet Gill, macro strategist of global fixed income at Goldman Sachs Asset Management, said the war in Ukraine will have a big impact on the paths taken by central banks.
“In a scenario whereby energy price rises weigh on growth, we expect a coordinated pause in monetary policy normalisation. By contrast, if fiscal support combines with rising energy prices to present upside risks to both medium-term inflation and inflation expectations, we could see more tightening than is currently anticipated,” she said.
This means the Fed will rely on data moving forward, rather than sticking rigidly to the revised dot plot.