The Federal Reserve is likely to approve a historic full percentage point interest rate hike when officials meet next week following warmer-than-expected August inflation data, according to analysts at Nomura Holdings.
“The materialization of upside inflation risks is likely to result in a 100bp Fed rate hike at the September FOMC meeting, above our previous forecast of 75bp,” Nomura said in an analyst note.
It would be the first rate hike of that size since the Fed began announcing moves in the overnight federal funds rate in 1994 and would set the benchmark range between 3.25% and 3.50%, the highest since the 2008 financial crisis.
Investors raised their expectations for a mega rate hike after a Labor Department report on Tuesday showed consumer price index increased by 8.3% in August compared to a year ago and 0.1% on a monthly basis, which gives investors an incentive to slow down inflation.
More worryingly, so-called core prices, which exclude more volatile measures of food and energy, accelerated again last month: Core prices rose 6.3% from a year earlier, above economists’ forecasts of 6.1%, and climbed by 0.6% on a monthly basis – a higher increase than in April, May, June and July and a worrying sign that the fundamental inflationary pressures they remain strong in the economy.
According to CME Group’s FedWatch tool, which monitors trading, Wall Street now sees a 28% chance of an extremely large rate hike at the Fed’s Sept. 20-21 meeting.
Federal Reserve Chairman Jerome Powell refused to rule out a 100-basis-point interest rate hike at the central bank’s July meeting, during which officials voted to raise interest rates by 75 basis points for the second straight month. Powell signaled that another increase of three-quarters of a percentage point could be on the table, but that the decision ultimately depended on upcoming economic data.
But that was before August’s inflation report, which experts agree was extremely poor, underscoring how strong inflationary pressures still remain in the economy. Bond yields rose sharply and stocks fell after the worse-than-expected report fueled fears that the Fed will have to step up its battle against inflation.
The Fed is in a precarious position as it walks the fine line between cooling consumer demand and bringing inflation closer to its 2% target without inadvertently dragging the economy into recession. Rising rates tend to create higher rates on consumer and business loans, which slows the economy forcing employers to cut back on spending.
Powell acknowledged the risk of a recession, but argued that it was more important for the Fed to tame inflation, even if an economic downturn followed.
“While higher interest rates, slower growth and softer labor market conditions will reduce inflation, they will also bring pain to households and businesses,” he said last month, speaking in Jackson Hole, Wyoming. “These are unfortunate costs of reducing inflation. But failure to restore price stability would mean far more pain.”