Fed in stride to pole-vault 5% policy rate, then perhaps catch its breath

Fed in Stride to Push Rates to 16-Year High

By Howard Schneider

The Federal Reserve kicks off a two-day policy meeting on Tuesday that is likely to push the U.S. central bank’s benchmark overnight interest rate to its highest level in nearly 16 years, hitting a potential plateau that will test the economy in a way not seen since the onset of the financial crisis in 2007.

Global central banks are all now edging their way towards a possible stopping point for rate increases after aggressively tightening credit conditions to tame the worst outbreak of inflation in 40 years. The Fed’s meeting will be followed with expected rate increases by the European Central Bank on Thursday and the Bank of England next week.

What to Expect

• The Fed’s second straight meeting after a major U.S. bank failure
• Expected rate increases by the European Central Bank and the Bank of England
• The U.S. central bank may signal that this week’s rate increase is the last, at least for now
• The economy is showing signs of ongoing strength as well as signs of a slowdown
• The Fed will announce its policy decision at 2 p.m. EDT (1800 GMT) on Wednesday

Given the tensions, “our base case remains that the May hike will be the last of this cycle as the economy responds to the tightening to date,” said Matthew Luzzetti, chief U.S. economist at Deutsche Bank. But “we see risks tilted toward another increase in June. (Fed) Chair (Jerome) Powell is likely to emphasize the continued need for a hawkish bias to tame inflation, but not commit to any decision at the June meeting.”

The anticipated quarter-percentage-point increase on Wednesday will put the target federal funds rate at roughly the same spot, between 5% and 5.25%. That’s the level most Fed officials last December and in March said they felt would be a proper stopping point, high enough to continue slowing inflation without, they hope, causing more of a slowdown in the economy – and more job losses – than needed.

Despite some financial market volatility, key parts of the real economy have motored along, with continued job growth, ongoing wage increases, and unemployment now lodged around a low 3.5% rate.

With this rate increase, Fed officials will hit a level that will be about 1 percentage point above the rate they consider to have a neutral impact on economic activity. That “restrictive” rate should cause households and businesses to curb spending and hiring, slowing inflation in the process.

Analysts expect the Fed from here to adopt a meeting-by-meeting strategy of watching data to see if inflation declines as anticipated, shows signs of persistence that require even higher rates, or falls so fast it warrants a rate reduction.

The meeting this week “will likely set the stage for a … period where hawks and doves duke it out over the June policy decision,” said Joe Brusuelas, chief U.S. economist at RSM. “Powell will likely eschew any idea that a rate hike pause is a foregone conclusion.”

(Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao)