US Fed hikes rates by half percentage point, starts balance sheet reduction June 1

Washington: The Federal Reserve on Wednesday raised its benchmark overnight interest rate by half a percentage point, the biggest jump in 22 years, and said it would begin trimming its bond holdings next month as a further step in the battle to lower inflation.

The US central bank set its target federal funds rate to a range between 0.75 percent and 1 percent in a unanimous decision, with further rises in borrowing costs of perhaps similar magnitude likely to follow.

Despite a drop in gross domestic product over the first three months of the year, "household spending and business fixed investment remain strong. Job gains have been robust," the rate-setting Federal Open Market Committee said in a statement following the end of its latest two-day policy meeting in Washington.

Inflation "remains elevated" with the war in Ukraine and new coronavirus lockdowns in China threatening to keep pressure high, it said. "The Committee is highly attentive to inflation risks."

The statement said the Fed's balance sheet, which soared to about $9 trillion as the central bank tried to shelter the economy from the COVID-19 pandemic, would be allowed to decline by $47.5 billion per month in June, July and August and the reduction would increase to as much as $95 billion per month in September.

Policymakers did not issue fresh economic projections after this week's meeting, but data since their last gathering in March have given little sense that inflation, wage growth, or a torrid pace of hiring had begun to slow.

Fed Chair Jerome Powell will brief reporters at 2:30pm in Washington, marking his first in-person press conference in more than two years, and investors will be listening for clues on how high the Fed is prepared to raise rates to cool price pressures.

The increase in the FOMC's target for the federal funds rate follows a quarter-point hike in March that ended two years of near-zero rates to help cushion the US economy against the initial blow from COVID-19.

Policymakers, who widely signaled their intention to step up the pace of rate increases, are trying to curb the hottest inflation since the early 1980s, when then-chair Paul Volcker drastically raised rates and crushed the economy in the process. They hope that this time around the combination of higher borrowing costs and a shrinking balance sheet will deliver a soft landing that avoids recession while tamping down inflation.

The personal consumption expenditures price index, the Fed's preferred gauge, rose 6.6% in the year through March, more than triple the central bank's goal - and a growing number of critics say the central bank waited too long to be able to stamp out inflation without causing a recession. Powell himself even told Congress in early March: "Hindsight says we should have moved earlier."

Investors are increasingly betting the FOMC will opt for an even bigger rate increase, of three quarters of a percentage point, when it next meets in June - which would be the largest single hike since 1994. Several officials have in recent weeks expressed a desire to "expeditiously" bring the federal funds rate to around 2.5% by the end of the year, a level they deem roughly "neutral" for the US economy.

The statement repeated prior language that said, "with appropriate firming in the stance of monetary policy, the committee expects inflation to return to its 2% objective and the labor market to remain strong." In addition, it reiterated that the Fed "anticipates that ongoing increases in the target range will be appropriate."

Officials decided to begin shrinking the Fed's $8.9 trillion balance sheet starting June 1, at a pace of $30 billion in Treasuries and $17.5 billion in mortgage-backed securities a month, stepping up over three months to $60 billion and $35 billion, respectively. The balance sheet had ballooned in size as the Fed aggressively bought securities to calm panic in financial markets and keep borrowing costs low as the pandemic spread.

The Fed said on Wednesday that "to ensure a smooth transition, the committee intends to slow and then stop the decline in the size of the balance sheet when reserve balances are somewhat above the level it judges to be consistent with ample reserves."

Powell told Congress in early March the process would take about three years, implying some $3 trillion in reductions.

Market expectations for a series of interest-rate increases have already pushed up borrowing costs and begun to constrain demand in rate-sensitive industries such as the housing market. The yield on the benchmark 10-year Treasury note rose to 3% this week for the first time since 2018.

Powell and his colleagues have increasingly sought to connect high inflation to strength in the US labour market. The US unemployment rate in March was 3.6%, just above its pre-pandemic level. The Labor Department will publish figures for April on Friday.

Officials must also calibrate the fallout from Russia's invasion of Ukraine, which has pushed up energy and food prices, even as Covid lockdowns in China add fresh strain to supply chains and downside risks to global growth.