Federal Reserve Readies to Take Rapid Steps With Interest Rates in 2022 to Fight Inflation

The Federal Reserve readies to take rapid steps with interest rates in 2022 to fight inflation, announcing Wednesday that it expects to raise interest rates three times next year.

The Fed said it will withdraw its monthly bond purchases at twice the speed it announced in the past and will likely end them in March. The faster pace allows the Fed to begin increasing rates as early as the first half of next year.

The new projection to raise interest rates three times in 2022 is up from one rate hike the Fed had estimated in September. The Fed's key rate, currently near zero, affects many consumer and business loans, such as mortgage, credit card, and auto loans.

Fed Chair Jerome Powell said the central bank needs to combat inflation to help the U.S. economy maintain its expansion, as it is likely to continue longer than the Fed had previously expected. However, Powell also said the economy is growing at a "robust pace" even with risks from the pandemic and believes that spending from consumers and businesses will continue to be strong.

"We will use our tools both to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched," Powell said during a news conference.

Borrowing costs could begin to increase in the upcoming months, but the Fed's actions don't always immediately impact other loan rates. It would also leave its standard rate historically low, under 1 percent, even if the central bank increases rates three times next year.

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The Federal Reserve's key interest rate, currently near zero, affects many consumer and business loans, such as mortgage, credit cards, and auto loans. In this photo, Federal Reserve Chairman Jerome Powell speaks during a Senate Banking Committee hearing on Capitol Hill in Washington on November 30, 2021. Andrew Harnik/AP Photo

The policy change reflects Fed policymakers' acknowledgment that with inflation pressures rising, the Fed needed to begin tightening credit for consumers and businesses faster than they had expected just a few weeks earlier. The Fed had earlier characterized the inflation spike as mainly a "transitory" problem that would fade as supply bottlenecks caused by the pandemic were resolved. The shift was signaled in testimony that Powell gave to Congress two weeks ago.

The run-up in prices has persisted longer than the Fed expected and has spread from goods like food, energy and autos to services like apartment rents, restaurant meals and hotel rooms. It has weighed heavily on consumers, especially lower-income households and particularly for everyday necessities, and negated the higher wages many workers have received.

Powell was asked at his news conference Wednesday what specifically had caused the Fed to pivot to a tighter credit policy.

"It was essentially higher inflation and much faster progress in the labor market," he said.

He acknowledged the possibility that inflation won't decline as expected next year.

"There's a real risk now," Powell said, "that inflation may be more persistent and that may be putting inflation expectations under pressure, and that the risk of higher inflation becoming entrenched has increased. I think part of the reason behind our move today is to put ourselves in a position to be able to deal with that risk."

Collectively, the Fed's policymakers forecast Wednesday that inflation, as measured by their preferred gauge, will reach 5.3 percent by year's end, up from their October reading of 5 percent. They expect inflation to slow considerably to a 2.6 percent annual rate by the end of 2022. But that's up from its September forecast of just 2.2 percent.

The officials foresee the unemployment rate falling to 3.5 percent by the end of next year, which would match the pre-pandemic level when unemployment was at 50-year lows.

The Fed is buying $90 billion a month in bonds, down from $120 billion in October, and had been reducing those purchases by $15 billion a month. But in January, it will reduce those purchases by $30 billion, to $60 billion, and will be on track, Powell said, to end them altogether in March. The bond buying has been intended to lower long-term interest rates and encourage more borrowing and spending.

The Fed is shifting its attention away from reducing unemployment, which has fallen quickly to a healthy 4.2 percent, down from 4.8 percent at its last meeting, and toward reining in higher prices. Consumer prices soared 6.8 percent in November compared with a year earlier, the government said last week, the fastest pace in nearly four decades.

The Fed's policy change does carry risks. Raising borrowing costs too fast could stifle consumer and business spending. That, in turn, would weaken the economy and likely raise unemployment.

Yet if the Fed waits too long to raise rates, inflation could surge out of control. It might then have to act aggressively to tighten credit and potentially trigger another recession.

Fed officials have said they expect inflation to cool by the second half of next year. Gas prices have already come off their peaks. Supply chain bottlenecks in some areas are gradually easing. And government stimulus payments, which helped spur a spike in spending that boosted inflation, aren't likely to return.

Yet many economists expect high prices to persist. That likelihood was reinforced this week by a government report that wholesale inflation jumped 9.6 percent for the 12 months ending in November, the fastest year-over-year pace on records dating to 2010.

The Associated Press contributed to this report.

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Borrowing costs could begin to increase in the upcoming months, but the Federal Reserve's actions don’t always immediately impact other loan rates. In this photo is the U.S. Federal Reserve on December 12, 2021, in Washington, D.C. Daniel Slim/AFP via Getty Images