Fed Likely to Raise Interest Rate by 0.5%: IMF Deputy Warns Inflation Could Get Worse

Reports suggest that the US Federal Reserve will drastically increase interest rates to curb growing inflation that hit a 40-year high last month. The move will see the Fed employ its fastest rate hike in decades to tackle the price surge Americans currently face aggressively.

However, the deputy managing director of the  International monetary fund (IMF), Kenji Okamura, revealed that Inflation might turn out faster than anticipated.

Anticipated FED Hike the Fastest in Decades

The Fed intends to announce the boosting of its benchmark short-term interest rate by 50 basis points (0.5%). The anticipated increase will be the steepest rate hike since 2000, with an announcement imminent at the end of the Fed meeting on Wednesday.

Following a previous interest rate increase in March, the Fed is expected to hike interest rates further this month. Economists anticipate more rate hikes in the months ahead, with one forecasted for June and another for July. 

Additionally, the Federal Reserve is anticipated to announce the rapid decrease of its massive Treasury and mortgage bonds stockpile. This will commence in June and would further limit lending even more. These steps are part of efforts to help slow the economy and restrain inflation with the threat of a recession imminent. 

Despite the best effort of the Federal Reserve, many economists believe they may be acting too late. With Inflation rising, the Fed’s benchmark rate is only between 0.25% to 0.5%, which is low enough to support growth. However, once adjusted for inflation, the benchmark is deep in the negative territory, hence the desire to raise it to a neutral level.

Furthermore, the sentiments of economists are supported further by Okamura. The IMF’s deputy MD thinks most Central Banks continue to underestimate the possibility of costs rising beyond their expectations. He warned that these institutions must closely monitor the situation and adjust policies immediately. He further reiterated the importance of funding to tackle pandemics and strengthen health systems globally. He said:

 “The international community should recognize that its pandemic financing addresses a systemic risk to the global economy, not just the development need of a particular country. Accordingly, it should allocate additional funding to fight pandemics and strengthen health systems both domestically and overseas. This will require about $15 billion in grants this year and $10 billion annually after that.” 

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Uncertainty Dominates US Economy as Further Interest Rate Hikes are Expected

A particular theme that seems to be dominating the Fed’s effort to curb rising prices is uncertainty. Many think that Chair Jerome Powell and the Federal Reserve will continue to make these decisions without a clear idea of how the economy will react. The situation is likened to driving in reverse while using the rear-view mirror by  Diane Swonk, the chief economist at the consulting firm Grant Thornton. 

Consequently, nobody knows how high the central bank’s short-term rate needs to be to slow the economy and keep inflation in check. Officials also are not sure how much of the Fed’s extraordinary $9 trillion balance sheet they can trim before risking financial market instability.

The dilemma is compounded further by the expected shrinking of the Fed’s balance sheet.  According to Brett Ryan, an economist at Deutsche Bank, the balance-sheet decrease will be roughly comparable to three quarter-point rises. Combined with the predicted rate hikes, this would result in a tightening of around four percentage points by 2023. Such a sharp increase in borrowing prices would throw the economy into recession by late next year, Ryan predicts.

However, the Fed is banking on a solid employment market and strong consumer spending to save the US from recession. Even though the economy declined by 1.4% in Q1 2022, firms and consumers boosted their expenditure at a steady pace. If the spending is maintained, it may keep the economy growing in the coming months.

Do you think the Fed’s faster interest rate hike and balance sheet tightening will help curb rising prices? Let us know your thoughts in the comments below.