Fed set for another big rate hike with economy on knife’s edge

Higher lending costs make it more expensive to borrow funds to buy cars and homes or expand businesses, which should cool demand, while also making it more attractive to save rather than spend.

Other major central banks have followed suit, including the European Central Bank which made its first move last week.

Fed Chair Jerome Powell last month said the policy-setting Federal Open Market Committee would consider either a 50 or 75 bps hike at the July meeting, and most economists expect a repeat of the June three-quarter-point increase.

Fed Governor Christopher Waller recently floated the idea of a mammoth 100-bps hike, which would be the first since the US central bank started using the federal funds rate for policy in the early 1990s.

The equivalent amount of tightening in a single move hasn’t been seen since the early 1980s, when then-Fed chief Paul Volcker was on a crusade to crush a wage-price inflationary spiral.

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But even Waller noted that it is important not to move too fast, and a full point hike would only be called for if data continue to show accelerating price increases.

“I think they will probably discuss 100 basis points just because the inflation picture is still very bad,” said Julie Smith, a Lafayette College economics professor.

But some recent data “indicate that previous rate increases have very likely started to work”, she said in an interview.

Housing prices have skyrocketed, hitting new records repeatedly, even as interest rates have risen, and consumer spending continues to increase, leading some economists to warn of a contraction in the second quarter.

But there are signs of cracks, including falling home sales, a dramatic drop in mortgage applications and an increasing share of spending going to necessities.

Officials have said the US economy is strong enough to withstand higher rates without a serious downturn, but others, including former Treasury secretary Lawrence Summers, say they are overly optimistic and job losses will have to rise sharply in order to tame inflation.

Kohn said it will be important for Powell to communicate clearly about what data the Fed is looking for to slow or pause the rate hike cycle.

“I think a fairly shallow recession,” with higher unemployment than the 3.7 per cent the Fed projected last month, “will be necessary to break this inflation spiral,” he said.

“But, boy, the amount of uncertainty around it is just huge.”