As expected, the Federal Reserve is raising its key rate by 50 basis points. The Central Bank is also doubling down on its balance sheet and taking $95 billion a month out of the financial system.
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It’s been 2,000 years ago—when the dotcom hype threatened the US economy to overheat—that the Federal Reserve raised interest rates so drastically in one fell swoop. Then it was also with 50 basis points. Normally, the Fed works in increments of 25 basis points or 0.25 percentage point. But the bank is shifting up a gear because inflation is skyrocketing. It is now 8.5 percent. Unlike in Europe, inflation is not solely caused by high commodity prices, but also by a very tight labor market. The Fed, which has to monitor price stability, therefore had no choice but to resort to the heavier means. It is the second rate hike since the Covid crisis. Interest rates were already raised by 25 basis points in March. The key interest rate is now at 0.75 -1 percent.
Taking money out of the market
The Fed is also accelerating its balance sheet contraction rate. For this, debt paper that the bank has purchased en masse (up to $8,900 billion at its peak) is not replaced at maturity. Shares and bonds can be sold. As a result, money and liquidities are withdrawn from the market. The pace of that tightening is doubling from $47.5 billion to $95 billion a month.
The financial markets, which have been under pressure for weeks due to rising interest rates, are reacting rather relieved. For a while, it was rumored that the Fed would raise interest rates by 75 basis points today. In that case, the markets would have reacted negatively.
In the press conference afterwards, Fed Chair Jerome Powell announced that the Fed will raise interest rates again by 50 basis points next time. He seemed to rule out an increase of 75 basis points in one go. He emphasized that the Federal Reserve’s decision was made unanimously within the interest rate committee. The Fed also stated in its accompanying message that it is “very alert to inflation risk,” a phrase not included last time, indicating that the Fed is now very serious about reining inflation. Analysts expect the US key rate to reach 3 percent by the end of the year.
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