Fed raises interest rates to crush wage demands

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The US Federal Reserve raised its base interest rate by 0.75 percentage points (75 basis points) in a bid to meet the wage demands of workers battling the highest inflation in four decades.

The increase is in line with market expectations following an article in the the wall street journal Monday, based on a leak, that the sharp rise was under consideration after it was specifically ruled out at the Fed’s previous policy-making committee meeting in May.

Federal Reserve Chairman Jerome Powell testifies before the Senate Banking Committee hearing, Thursday, March 3, 2022, on Capitol Hill in Washington. (Tom Williams, Pool via AP)

In his opening remarks at the press conference following the Fed’s two-day meeting yesterday, Chairman Jerome Powell sought to give the impression that the central bank was in control despite the U-turn.

He said the Fed understood the difficulties high inflation was causing and was moving quickly to bring it down. “We have both the tools we need and the determination it will take to restore price stability on behalf of American families and businesses.”

But this assertion was contradicted in the statement of the Federal Open Market Committee announcing the monetary policy. He deleted a sentence in the May statement that said officials expected inflation to return to 2% and the labor market to remain strong as he raised interest rates.

Asked about the excision, Powell said it reflected feelings that the Fed could not cut inflation to 2% on its own and was not accurate.

This admission served to underscore that the Fed’s latest decision is not about cutting inflation – the result of supply-side restrictions resulting from the COVID-19 pandemic, the injection of trillions of dollars in the financial system over the last decade and a half and NATO’s proxy war against Russia, but aims to suppress wage demands.

Powell repeated remarks, made on numerous previous occasions, that the labor market was “very tight”.

He said the impetus for the decision to raise rates by 75 basis points – the biggest single hike since 1994 – came from two reports late last week.

The confidence survey compiled by the University of Michigan indicated that consumer sentiment fell to an all-time low on fears that inflation was anchoring itself and last Friday’s report jumped to 8 .6% in May.

The decision, Powell’s comments and Fed officials’ projections for growth rates make it clear that the central bank intends to try to squash this move by slowing economic growth and pushing the economy into a recession if necessary.

When inflation started to rise in 2021, Powell and other Fed officials argued that it was “transitional.” Now this fiction is replaced by an equally false one, according to which there is the possibility of a so-called “soft landing”.

But, as former US Treasury Secretary Lawrence Summers insisted, interest rates are a blunt instrument and incapable of producing a smooth trajectory.

Even Powell was forced to backtrack somewhat, saying the path to a recession-free soft landing “doesn’t get any easier” as it becomes clear that “many factors beyond our control are going to play a very important role. in the decision whether it is possible or not.

But the use of the blunt instrument of interest rate hikes was to continue regardless.

“The worst mistake we could make would be to fail, which is not an option. We need to restore price stability,” he said.

In other words, wages are the key objective and, as Powell said in his opening statement, “the conditions of supply and demand in the labor market” must “be better balanced”.

He noted that currently there are two vacancies for every person seeking employment and the aim is to restore pre-pandemic conditions. It was a situation in which real wages were continuously falling.

There are already indications of weaker growth. Powell noted that growth in business fixed investment is slowing and “activity in the housing sector appears to be slowing.” He argued that consumer spending remained strong, but the latest reports indicate that retail sales are starting to decline because consumers have less disposable income to spend in the face of rising prices for gasoline and other items. essential.

In their projections for the economy, Fed officials predict weaker growth. Their median forecast was for growth to slow to 1.7% by the end of this year and stay at that level in 2023. This compares to their previous forecast in March of 2% growth over the next two months. years.

Officials’ interest rate projections – the so-called “dot chart” – show a sharp hike in the Fed rate.

The median projection would take the Fed’s base rate to around 3.38% by the end of the year, meaning there will be further increases totaling 1.75 percentage points over the next four months. meetings. In March, the projection for the end of the year was for a base rate of around 1.88%. Officials also expect the unemployment rate to rise from its current level of 3.6% to 4.1% by 2024.

Announcing the decision, Powell said he did not expect moves of this magnitude to be common and added that the decision from the Fed’s July meeting “may well be a decision between 50 and 75 “basic points.

This was to reassure markets up as much as 1 percentage point, which have been mooted in some quarters, were not under consideration. Wall Street duly responded with all three major indexes – the Dow Jones, S&P 500 and NASDAQ – ending for the day.

But there was a similar response in May when Powell said a 75 basis point increase was “not something the committee was actively considering” only to fall sharply the next day.

Besides its impact in the United States, the Fed’s latest decision will have far-reaching international ramifications, putting additional pressure on all central banks to continue and even accelerate the interest rate hikes they have already begun in response to the global inflationary surge.

This week, Reserve Bank of Australia Governor Philp Lowe warned that more interest rate hikes were on the way, following a 0.5 percentage point hike earlier this month. It was “unclear at this time” by how much they would need to increase to meet the 2% inflation target, with Lowe predicting that inflation could rise from its current level of 5.1% to 7%.

The European Central Bank (ECB) is also facing a series of problems. As the Fed proceeded with its rate hike, it held an emergency meeting to counter fears that it is on the verge of another debt crisis as it begins to raise interest rates in July and stop buying more bonds.

The decision to call the meeting came just a week after the ECB’s governing council met to set its monetary policy and was the first such gathering since the March 2020 financial crisis at the start of the pandemic.

The central concern is the so-called “fragmentation” in which interest rates on sovereign bonds of the most indebted southern members of the eurozone move significantly above rates on German bonds.

The difference between interest rates on Italian and Spanish bonds and German debt has reached levels not seen since the start of the pandemic. The fear is that if this continues it will lead to a single currency crisis as happened in 2012.

Announcing the meeting, the ECB said the pandemic had left “lasting vulnerabilities in the eurozone economy”. He said he would accelerate work on developing a new instrument to deal with soaring borrowing costs for weaker economies, but gave no details on what that would entail.

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