The Federal Reserve on Wednesday predicted U.S. inflation would exceed 5% by the end of 2022 — much higher than its most recent forecasts — underscoring its more aggressive strategy in raising interest rates.
The central bank lifted its benchmark short-term rate by 75 basis points to a range of 1.5% to 1.75%. It marks the biggest rate increase in 28 years.
The Fed also plans to raise the rate to as high as 3.8% by 2023, according to its latest “dot plot” forecasts. After that, rates are forecast to decline.
The bank’s more hawkish approach after several years of heavily stimulating the economy comes in the wake of another poor reading on inflation. The consumer price index jumped 1% in May to push the increase over the past year to a 40-year high of 8.6%.
The Fed prefers another measure known as the personal consumption expenditures index as a better gauge of inflation. The PCE index has also risen a sharp 6.3% as of the 12 months ended in April.
By the end of this year, the Fed predicts a 5.2% rate of inflation as measured by the PCE index. That’s up from its 4.3% forecast in March and 2.6% as recently as December.
The Fed then expects inflation to slow sharply to 2.6% by the end of 2023 and 2.2% by 2024 — an optimistic forecast not shared widely by Wall Street economists.
“That’s a bit more realistic than the March projections, which were totally unrealistic, but it still looks like a long shot to pull off,” said economists Thomas Simons and Aneta Markowska of Jefferies.
The Fed also predicts the economy will weaken but not fall into recession.
Gross domestic product is forecast to increase just 1.7% in 2022, down from a prior 2.8% estimate. The economy would also grow 1.7% in 2023 before picking up slightly in the following year.
The U.S. unemployment rate, now near a 54-year low of 3.6%, is seen edging up slightly this year and rising to 4.1% by 2024. Fed Chairman Jerome Powell said there’s too much demand for labor and not enough supply, a problem he hopes higher interest rates will ameliorate.
“We are not seeking to put people out of work,” Powell emphasized, “but you have to have price stability. We have to restore that” to have a good labor market in the long run.
If the Fed’s forecasts are spot on, the central bank signaled it would be able to lower rates again by 2024. The central bank predicts its short-term rate would fall to 3.4% from 3.8%.
Given the Fed’s poor forecasting record over the past year, economists say, it will take time to see if the central bank’s tougher medicine does the job.