The Fed Finally Increases Rates

The US Federal Reserve has finally moved on interest rates, increasing the federal funds rate by 25 basis points to 0.25%. The Fed also indicated that they expect to keep increasing rates until they get to 1.75% to 2.00%, or back to the ‘natural rate’. The Fed also announced that they would be cutting back their bond purchasing program.

While this is clearly a move to bring inflation under control, the Fed remains optimistic that they won’t be pushing rates up aggressively, and sacrificing jobs and growth to get inflation under control. Rather than increasing rates aggressively to reduce demand and ‘tank’ the economy to get inflation under control, the Feb believes that a gentle correction in rates coupled with the economy returning to ‘normal’, as the COVID and war induced supply shocks ease, will be sufficient to bring inflation down. They have also indicated an appetite to allow the economy to run hot for an extended period of time to allow these factor to play out.

This is a risky move akin too playing with fire. By taking such a cautious approach, the Feb continues to run the risk that inflation gets out of control and a more aggressive correction is ultimately required to bring inflation back to sustainable level. The gamble might pay off, but the costs will be high if they have miscalculated.

The move by the Fed will also pave the way for the Reserve Bank of Australia to start its cycle of interest rate increases. While inflation has not reached the same levels in Australia as it has in the USA, the factors influencing the economy are largely the same and we can see in the USA a vision to the high inflation future that faces Australia if the RBA continues to sit on its hands.