Expectations grow that US central bank will raise borrowing costs by 0.75 percentage points

The Federal Reserve is on Tuesday set to begin discussing whether to increase the pace of its monetary tightening in the face of worsening inflation as expectations rise that it will raise interest rates by 0.75 percentage points. The Federal Open Market Committee will convene for a two-day gathering just days after the latest economic data suggested that price pressures had become more relentless than expected. Before figures released on Friday — which showed prices jumped another 1 per cent in May from the previous month — the Fed had signalled it was poised to approve a second consecutive half-point rate increase. But a larger rise of 0.75 percentage points is now likely to be under consideration. Markets have almost fully priced in that outcome with economists at JPMorgan, Goldman Sachs and Barclays all now anticipating a 0.75 percentage point rise — which would be the first since 1994.

Equity markets were battered on Monday by rising concerns that intense inflation will trigger a further sharp tightening of US monetary policy. The US S&P 500 slumped almost 4 per cent to close at its lowest level since the start of 2021. US stocks were set to steady on Tuesday, with futures contracts tracking the S&P 500 up 0.2 per cent. In Europe, the region-wide Stoxx 600 share index fell a further 1.1 per cent after a 2.4 per cent slide in the previous session. The Wall Street Journal first suggested that Fed officials would discuss a 0.75 percentage point increase. Krishna Guha, vice-chair at Evercore, said such a move was “not what we think is optimal policy, and, separately, not in our view good for markets”. Economists are grappling with what comes after the Fed meeting as the central bank confronts more inflation shocks that have raised doubts over whether it is moving swiftly enough to address what is already becoming an intractable problem.

The Fed has committed to moving “expeditiously” to a neutral setting — one that neither stimulates nor slows down growth — although chair Jay Powell recently conceded that threshold was “not something we can identify with any precision”. Rather, he vowed to keep pressing ahead until there was “clear and convincing” evidence that inflation was moderating. US central bankers will convey their forecast policy path in an updated “dot plot” to be released on Wednesday, which maps out individual interest rate projections as part of a broader set of estimates about the economic outlook. In its most recent set of projections, published in March, top officials pencilled in a benchmark policy rate of 1.9 per cent by the end of the year, and 2.8 per cent in 2023. Policymakers are also due to publish updated forecasts for inflation, growth and unemployment, which are expected to reflect Powell’s recent admission that moves needed to tame price pressures will lead to “some pain”. Economists had taken issue with March’s estimates, which suggested little movement in the unemployment rate from historically low levels even as policy became significantly tighter.

Powell has since acknowledged that the unemployment rate was likely to rise “a few ticks” and that the central bank might only be able to achieve a “softish” landing for the economy. The Fed “can’t go all guns blazing now without some spillover”, said Gargi Chaudhuri, head of iShares investment strategy for the Americas at BlackRock. Economists had broadly expected the median unemployment rate forecast to reach about 3.8 per cent by 2024, 0.2 percentage points higher than its current level, with officials pegging inflation closer to 5 per cent this year.

A more substantive slowdown in gross domestic product growth is also anticipated. That, in turn, has increased the odds that some policymakers will predict outright rate cuts in 2024, reflecting the belief that the economy will have slowed notably by then. A recent poll of leading academic economists by the Financial Times showed that nearly 70 per cent believed the US economy will tip into a recession next year. Priya Misra, head of global rates strategy at TD Securities, said the Fed was confronting a much more difficult problem than just a few months ago. “They have two-sided risks now with growth and inflation,” she said. For Stephanie Aaronson, a former Fed staffer now at the Brookings Institution, the central bank will need substantial luck to avoid a hard landing. “If they don’t get much help on the supply side in terms of relief on energy and food prices . . . and they really have to do a lot more of the work on bringing down inflation themselves, they would not be able to do that with a soft landing,” Aaronson said.