Federal Reserve raises interest rates by 0.5%

The US Federal Reserve raised interest rates by 0.5%, taking the base rate to a 15-year high as part of its attempts to control rising inflation.

The benchmark interest rate now sits at a range of between 4.25% to 4.5%.

However, it looks as if the central bank is going to slow the pace of rate hikes going forward.

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After announcing the rate change, Jerome Powell, chair of the Federal Reserve, said “the appropriate thing to do now is to move to a slower pace” and see how the economy responds to higher interest rates.

He also said the Fed expects inflation to remain high into next year. The US Bureau of Labor Statistics reported earlier this year that prices have risen by 7.1% from last November, increasing 0.1% from October.

The Fed’s interest rate announcement preceded the BoE’s interest rate hike of 0.5% as both central banks face the difficult task of controlling rising inflation without causing too much harm to their respective economies.

Why is the Federal Reserve raising interest rates?

While November’s 7.1% figure is an improvement from June’s 9.1% rate of inflation, which was the highest in 40 years, it’s still three times higher than the Fed’s target of 2%.

The Federal Reserve has been increasing rates at a fast pace as it looks to control inflation.

The easing figures in October were mostly due to falling gas prices. However, the cost of healthcare, rent, and dining out remains high with rent driving the cost of living up the most.

Increased interest rates make the cost of borrowing higher, which in turn encourages saving.

So in theory, they should help bring prices down as people spend less and businesses compete for custom by decreasing prices. But because they discourage spending, they also slow down the economy.

“Inflation has been falling since the summer when the rate peaked at the highest level in over 40 years, 9.1%, compared to yesterday’s 7.1% reading,” says Dan Boardman-Weston, CEO and chief investment officer at BRI Wealth Management.

“This seems to have given the Fed confidence to slow the pace of interest rate increases, even though rates are likely to rise to a higher level and remain there for longer than expected a few months ago.”

But Powell added that while the October and November figures were encouraging, “it will take substantially more evidence to give confidence inflation is on a sustained downward path”.

What do rising interest rates mean for you?

By hiking interest rates the Fed is making it more expensive to borrow money, which should reduce demand for goods and services.

For example, 30-year mortgage rates have spiked to 6.3% over the past year, pushing up the cost of buying a home. As a result, property prices have started to fall as buyers reconsider their options.

Still, with the Fed now expected to slow the pace of rate hikes going forward, borrowers could see rates fall as the market settles into the new normal. Indeed, the average 30-year mortgage rate hit a 20-year high of 7.08% in November, but, as noted above, the rate has now dropped back to 6.3%.

Unfortunately, it does not look as if the central bank will be cutting rates any time soon, suggesting the outlook for equities is going to remain uncertain.

Both the S&P 500 and the Nasdaq saw losses following the Fed’s decision, closing 0.60% and 0.80% lower respectively.

“We expect that higher rates will subdue economic activity in 2023 and that this will lead to corporate profits falling and equities remaining under some pressure,” says Boardman-Weston.

“It’s become clear this year that the Fed is intent on crushing inflation and future expectations of inflation. The higher interest rate environment required to tame inflation comes at the cost of economic growth, which likely comes at the cost of lower stock markets.”