17/09/26, US Federal Reserve

The US Federal Reserve raised interest rates by 25 basis points on Wednesday, delivering its first hike since July 2023 as stubborn inflation, higher energy prices and a resilient economy prompted policymakers to resume monetary tightening after more than three years.

The Federal Open Market Committee unanimously raised the federal funds rate target range to 3.75-4 percent, reversing part of the easing delivered since the Fed ended its previous rate-hike cycle. More importantly, policymakers signalled that Wednesday's move may not be a one-off, with most officials expecting rates to rise further this year.

So, what prompted the Fed to start raising interest rates again after more than three years?

Inflation remains the US Fed's biggest concern

Persistent inflation has become the central concern for policymakers. Overall US inflation stood at 3.7 percent year-on-year in July, while core inflation was 3.3 percent, both remaining above the Fed's 2 percent objective. More recently, the Consumer Price Index for August rose 0.4 percent from the previous month, taking the annual inflation rate to 3.4 percent.

Higher energy prices have complicated the inflation outlook. The conflict in the Middle East has disrupted global energy markets and pushed crude oil above $100 a barrel, increasing concerns that price pressures could become more persistent and spread beyond energy.

The Fed also made a notable change to its assessment of inflation. Its latest statement dropped an earlier reference attributing elevated inflation to "supply shocks", particularly in the energy sector. The change comes as policymakers have grown more concerned that inflationary pressures are becoming broader.

At the same time, the US economy has remained resilient enough to give the Fed room to tighten monetary policy. Policymakers project economic growth of 2.3 percent in 2026 and 2.4 percent in 2027, while the unemployment rate is seen at 4.1 percent.

Together, persistent inflation and continued economic resilience have shifted the balance towards higher interest rates, despite the Fed having spent the previous phase of its policy cycle lowering borrowing costs.

First Fed rate hike of Kevin Warsh era

Wednesday's decision assumes added significance because it is the first interest-rate change since Kevin Warsh became Fed chair in late May.

President Donald Trump selected Warsh to lead the Federal Reserve after repeatedly calling for lower interest rates and had said during the selection process that he expected his appointee to favour lower borrowing costs.

The Fed's latest decision instead moves monetary policy in the opposite direction, with the central bank raising rates and its projections leaving the door open to further tightening.

Warsh had already hardened his rhetoric on inflation before the September meeting. At the Jackson Hole symposium last month, he said policymakers needed confidence that underlying inflation was moving towards the Fed's objective "clearly and at sufficient speed".

Wednesday's unanimous decision also comes after three policymakers had favoured raising rates at the Fed's July meeting.

The latest move effectively reverses part of the easing delivered by the central bank after its previous tightening cycle. The Fed had last raised rates in July 2023 and subsequently cut borrowing costs six times by a cumulative 175 basis points.

written by Shaleen Agrawal 

Source: Network18