The Fed will raise interest rates again amid pressure from core inflation

The United States is bracing for an interest rate hike on Wednesday that could send the world’s largest economy into recession.

The Federal Reserve is expected to announce another quarter percentage point increase in its benchmark interest rate, to a range of 5% to 5.25%. It would be the tenth consecutive rate hike by the central bank, as it prioritizes the fight against rising prices. A year ago interest rates were close to zero.

Annual headline consumer inflation fell in the US in March from 6% to 5%, but core inflation, which does not include energy and food price volatility, increased from 5.5% to ​5.6%

Economists are divided on whether the Fed should stop raising rates. Adam Posen, who heads the think tank at the Peterson Institute in Washington DC, said it was important for the US central bank to “continue its ramp-up cycle given what the latest data tells us.”

However, Robert J. Shapiro, one of Bill Clinton’s economic advisers when he was president, said the Fed should stop dead because it had already done enough to calm the economy. Further rate increases risked a recession that would hurt low- and middle-income workers.

US economic growth slowed sharply in the first quarter of the year, to just 1.1% year-on-year, from 2.6% growth in the last three months of 2022. It was significantly lower than US expectations. economists of a growth of 2%.

“A decline in economic growth to 1.1% shows that it is time for the Fed to pause,” Shapiro said.

“There is a significant lag between interest rate hikes being imposed and their effect, so we know the economy will suffer more even without further rate hikes.”

Neil Shearing, chief economist at consultancy Capital Economics, said the Fed would raise rates by a quarter of a percentage point. “Then it’s done. And that’s because there are already significant signs that the economy is slowing.

“The job market is cooling off and given all the problems in the US banking system and the tightening of credit conditions, higher rates will not be required,” he added.

An interest rate hike in the US is expected to be followed on Thursday by a quarter percentage point rise in interest rates in the eurozone. The European Central Bank (ECB) is expected to raise its main rate for the seventh consecutive time, to 3.75%.

The Bank of England is expected to raise interest rates for the twelfth time in a row next week, taking them to 4.5%.

Everyone is fighting rapidly rising prices, but the story of inflation is not the same everywhere.

While the headline rate fell in the US in the latest data for March, figures released Tuesday showed eurozone inflation rose to 7% in April from 6.9%. In the UK, inflation fell from 10.4% in February but remained stubbornly high in March at 10.1%.

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Yet central bank policymakers are all singing the same tune because the measure of core inflation that excludes food, fuel and energy prices is well above their comfortable rate.

In March, core inflation reached 5.7% in the UK and the euro area (before falling to 5.6% in April in the single currency bloc) and 5.6% in the US.

It’s part of the reason policymakers say higher interest rates are needed, which reduce demand for goods and services and thus ease inflationary pressures.

The sticky nature of core inflation means there is no doubt in the minds of City analysts that interest rates in the US, UK and Eurozone are about to rise again. The only question is which central banks will think they have done enough and which will say they need to continue beyond this month.

Posen was a moderate member of the monetary policy committee in the immediate aftermath of the 2008 financial crisis, favoring lower rates and arguing at the time against those who wanted to raise borrowing costs to cope with rising inflation.

“They described me as a super pigeon. But this time the UK is facing a different situation,” she said. “A further increase by the Bank of England is a foregone conclusion and that is the right decision. The Bank is still behind the inflation curve, in my opinion”.

John Llewellyn, former chief economist at the Organization for Economic Co-operation and Development, said there was a strong possibility that the Bank of England and the ECB would be forced to keep raising rates until they see significant declines in core inflation.

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