Fed signals interest rate hikes could come as early as 2022

FILE - In this May 22, 2020, file photo, the Federal Reserve building is viewed in Washington. Federal Reserve officials last month expressed concerns about the severity of the economic downturn triggered by the coronavirus pandemic. The minutes of the June 9-10 discussions that were made public Wednesday, July 1, 2020, show officials grappling with economic disruptions that had already occurred. (AP Photo/Patrick Semansky, File). (AP Photo/Patrick Semansky, File)

The Federal Reserve on Wednesday cleared the way to reduce its monthly bond purchases “soon” and signaled interest rate increases may follow more quickly than expected, with nine of 18 U.S. central bank
policymakers projecting borrowing costs will need to rise in 2022.

The actions, which were included in the Fed’s latest policy statement and separate economic projections, represent a hawkish tilt by a central bank that sees inflation running this year at 4.2 per cent, more than double its target rate, and is positioning itself to act against it.

That action may proceed slowly, with interest rates seen rising to one per cent in 2023, faster than projected by the Fed in its projections in June, and then to 1.8 per cent in 2024, which would still be considered a loose monetary policy stance.

Read more: Interest rate hike will depend on economic recovery, Bank of Canada says

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Inflation throughout that time would be allowed to run slightly above the Fed’s two per cent target, consistent with its new, more tolerant approach to the pace of price increases, while unemployment is seen falling back to around the pre-pandemic low of 3.5 per cent.

Still, the shift shows movement among policymakers divided over whether the coronavirus pandemic’s ongoing impact on the economy or the threat of breakout inflation constitutes the bigger risk.

The Fed on Wednesday held its current target interest rate steady in a range of 0 per cent to 0.25 per cent.

U.S. stocks extended gains after the release of the statement, with the S&P 500 index up 1.3 per cent on the day. The dollar reversed course and moved lower, while the yield on the U.S. 10-year Treasury note was slightly lower.

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Though acknowledging the new surge of the pandemic had slowed the recovery of some parts of the economy, overall indicators “have continued to strengthen,” the central bank’s policy-setting Federal Open Market Committee said in a unanimous statement.

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If that progress continues “broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted,” it said.

The statement had been widely expected to signal that the Fed would soon begin winding down the $120 billion in monthly bond purchases it has been making to blunt the economic impact of the pandemic.

Read more: Bank of Canada holds key rate, warns 4th COVID-19 wave could hamper recovery

But it was in their broader economic outlook that Fed policymakers made a less anticipated change.

The outlook for inflation jumped 0.8 percentage point for 2021 and the unemployment rate seen at the end of this year rose. In turn, two officials brought forward into 2022 their projected timeline for slightly lifting the Fed’s benchmark overnight interest rate from the current level, enough to raise the median projection to 0.3 per cent for next year.

(Reporting by Howard Schneider Editing by Paul Simao)

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