The Fed expects more rate hikes, despite a smaller 50 basis point increase: 'We still have a long way to go'
As was widely expected, the Federal Reserve announced a 0.50 percentage point interest rate hike Tuesday, further increasing the costs of credit cards, auto financing and variable-rate loans.
Rate increases aim to slow inflation, but they also boost the cost of borrowing. In the last year, interest rates have jumped by about 3% for credit cards, and have nearly doubled for auto financing and adjustable-rate loans and mortgages. With Tuesday's increase, those costs will rise slightly.
The good news is that the central bank's benchmark rate increase is smaller than four previous "jumbo" hikes of 0.75 percentage point. That means that the central bank is finally slowing the rate of its increases for the first time in 2022.
The smaller hike reflects the Fed's belief "that inflation will continue to moderate," says Greg McBride, chief analyst at Bankrate.
However, with the year-over-year rate of inflation still above 7%, "we also have to check our expectations at the door" when it comes to rate increases, and therefore inflation, ending anytime soon, says McBride.
When will inflation get better?
Rate hikes can decrease inflation, but it takes around nine to 12 months before the "full effect" of those increases are felt in the economy, says McBride.
That means it might take all of 2023 before inflation subsides to the Fed's target rate of 2%. It also means that rate hikes will likely continue if the rate of inflation doesn't budge in that time.
"We still have a long way to go," before inflation is fully under control, says McBride. "We could see a meaningful drop in inflation in 2023, and still only be halfway to where we need to be by this time next year."
With the most recent increase, the federal funds rate — which influences the minimum interest rates that banks charge consumers — has increased to a range of 4.25% to 4.5%. That's the highest it's been in 15 years.
But because more rate hikes are expected, the federal funds rate is predicted to peak at 4.75% to 5%, according to many forecasts, including a recent Bloomberg survey of 44 economists. Other forecasts project a higher rate of 5% to 5.25%. This includes Goldman Sachs, which expects three additional hikes of 0.25 percentage point in early 2023.
Despite the Fed's stated commitment to bringing inflation down to 2%, that benchmark could change to 3% if the economy worsens, says McBride. In that case, it's possible the Fed could start slashing rates sooner.
"I'd be very surprised if that happens in the near term, because they have to work on restoring inflation credibility at this point, not eroding it further," says McBride.
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