Fed’s February 2023 interest rate decision: A quarter point increase

The Federal Reserve raised its benchmark interest rate by a quarter of a percentage point on Wednesday, showing little sign that the hike cycle is nearing its end.

The Federal Open Market Committee raised the federal funds rate by 0.25%, in line with market expectations. That puts it within a target range of 4.5% to 4.75%, the highest since October 2007.

The move was the eighth increase in a trend that began in March 2022. In itself, the funds rate determines what banks charge each other for overnight borrowing, but it also trickles down to many consumer debt products.

The Federal Reserve is raising interest rates as it aims to reduce inflation, which remains near its highest level since the early 1980s despite recent signs of easing.

The post-meeting statement noted that inflation had “declined somewhat, but remained high,” a reversal of earlier language.

However, markets were looking for signs that the Federal Reserve will end interest rate hikes soon. But the statement did not provide such indications. Initially, stocks fell after the news was announced, with the Dow Jones Industrial Average falling more than 300 points.

The document included language indicating that the FOMC still sees the need for “continued increases in the target range.” Market participants had hoped that the wording would be watered down a bit, but the unanimously approved statement kept it intact.

The statement changed one section when describing what would determine the direction of future policy.

Officials said they would determine the “magnitude” of future rate hikes based on factors such as the impact of rate hikes, the lags in policy impacts and developments in financial and economic conditions. Earlier, the statement said it would use those factors to determine the “pace” of future increases, a possible hint that the committee will end hikes somewhere, or at least continue to make smaller moves in the future.

In 2022, the Fed approved four consecutive 0.75% hikes before settling on a smaller 0.5% increase in December. In recent public statements, several officials said they thought the central bank could at least reduce the rate of hikes, without indicating when they might end.

While raising its benchmark rate, the committee described economic growth as “modest,” although it noted only that unemployment “remains low.” The latest labor market assessment removed previous language that employment gains were “strong.”

Otherwise, the statement remained unchanged from previous messages as the Federal Reserve continued its efforts to contain inflation.

The Fed is very focused on inflation

Fed policy is thought to work on lag — when the central bank raises rates, it takes time for the economy to adjust to tighter controls on money.

This particular round of inflation was triggered by covid-related factors such as supply chain disruptions and increased demand for goods over services. The war in Ukraine exacerbated gas price hikes, while unprecedented fiscal and monetary stimulus drove up spending on a variety of goods and services.

Food prices have increased by more than 10% in the last year. Egg prices alone are up 60 percent, butter is up more than 31 percent and lettuce is up 25 percent, according to Labor Department data through December. Gasoline prices fell in late 2022, but have risen in recent days to $3.50 a gallon nationally, up about 30 cents over the past month, according to AAA.

Federal Reserve officials have remained tight-lipped about tackling inflation, although they have said recent numbers suggest pressures may be easing. The consumer price index fell 0.1 percent month-on-month in December and rose 6.5 percent from a year earlier — down from a peak of 9 percent last summer but still well above where the Federal Reserve feels comfortable.

Buy Federal Reserve bonds

At the same time as interest rates have increased, the Federal Reserve has reduced the assets in its bond portfolio. That has resulted in a drawdown of about $445 billion since June, as the Fed targets a capped $95 billion level in maturing bonds, allowing them to draw down each month instead of reinvesting.

According to the San Francisco Federal Reserve, the balance sheet reduction was equivalent to about a 2 percent additional rate increase. The balance sheet is still over $8.4 trillion.

Markets are looking to see where the Fed will end up.

At the FOMC’s December meeting, committee members announced they knew the “stop rate,” or the point at which the Fed thinks policy is restrictive enough, is 5.1 percent. Markets are betting that number will be closer to 4.75 percent, and they expect the Federal Reserve to start cutting interest rates later this year after a quarter of hikes in March.

Stocks rallied to start 2023 as investors expected the Federal Reserve to be less restrictive.

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