With economic fallout from Russia’s invasion of Ukraine heightening U.S. inflation rates that were already at record highs before the attack began, the Federal Reserve is set this week to raise interest rates for the first time in three years in an attempt to rein in skyrocketing consumer costs.
The expected .25% increase will be the first in a series of Fed actions aiming to dampen U.S. inflation, which has hit 40-year records in each of the last three months of year-over-year tallies, including the7.9% February rate reported by the U.S. Labor Department last week.
February inflation was even higher for consumers in the Mountain West states, which include Arizona, Colorado, Idaho, Montana, Nevada, New Mexico, Utah and Wyoming, where the 12-month increase in prices hit a nation-leading 9.7%.
With a war raging in Europe and price increases at a four-decade high, Fed Chairman Jerome Powell will seek to engineer a “soft landing” or gradual slowdown in economic activity that helps curb surging price hikes, while keeping the job market and economy expanding.
Yet many economists worry that with the price of oil and other commodities spiking, the additional burden of higher interest rates could choke off growth entirely.
“You’ve got to be both lucky and good” to avoid causing a downturn, said Alan Blinder, a Princeton University economist who served as vice chairman of the Fed from 1994 to 1996, when the central bank was widely seen as having successfully raised rates without triggering a recession.
As a first step, the Fed is set to raise borrowing rates several times this year, beginning this week with a modest quarter-point increase in its benchmark short-term rate. The policymakers will also discuss when and how fast to shrink the Fed’s $9 trillion in bond holdings, a step that would also have the effect of tightening credit for consumers and businesses.
Phil Dean, former state budget director and public finance senior research fellow at the University of Utah’s Kem C. Gardner Policy Institute, said the interest rate increases by the Fed lead to higher costs for borrowing and finance, and that will impact Utah consumers and businesses in a variety of ways.
“Increasing interest rates at the monetary policy level leads to higher rates and dampened activity for things we finance,” Dean said. “Home loans, car loans, business equipment investments, buildings, will become more expensive as rates go up.”
Dean said the challenge for the Federal Reserve strategy on its planned series of rate hikes will be finding just the right balance of reducing inflationary pressures but doing so without impeding the overall growth of the U.S. economy.
And, it’s a target that comes with unprecedented challenges, thanks to the trillions of dollars pumped into the economy over the past two years in an effort to manage the impacts of COVID-19 and, most recently, the economic fallout from Russia’s attack on Ukraine.
“The Fed has never had to deal with this enormous level of fiscal stimulus, a lot of which is still in the bank accounts of individuals and businesses,” Dean said. “It’s unclear how that money may be spent and it represents an overhang, of sorts, that is very hard for the Fed to predict as it makes changes to monetary policy.”
Dean noted that Utahns who have fixed-rate loans for big purchases like homes and vehicles are better protected on a personal finance level than those whose big-ticket loans have variable interest rate clauses. Also, those who are carrying debt on things like variable rate credit cards will be seeing larger, interest-driven fees attached to their balances.
The Fed’s upcoming interest rate hike, expected to be announced Wednesday, as well as planned discussions on reducing bond holdings, represents a sharp turn away from the board’s ultra-low rate policies, which it enacted when the pandemic recession erupted two years ago.
The Fed, by its own admission, underestimated the breadth and persistence of high inflation after the pandemic struck. Many economists say the central bank made its task riskier by waiting too long to begin raising rates.
The average 30-year fixed mortgage rate, which reached a record low of 2.65% in January 2021, has jumped to 3.85% in the past three months as Powell has signaled the Fed’s intentions and inflation has spiraled higher.
By raising short-term rates, the Fed hopes to make it costlier to buy homes and cars and to boost credit card rates and borrowing costs for businesses. The resulting pullback in spending should, in turn, slow inflation, Powell told Congress two weeks ago. Strong consumer spending, fueled by stimulus checks and steady hiring and pay raises, has collided with supply shortfalls to raise inflation to 7.9%, the highest rate since 1982.
The biggest drivers of that rate increase have been jumps in the cost of gas, groceries and housing across the U.S.
On Monday, the average price of gas, according to daily market reporting by AAA, was $4.36 a gallon, a record high for Utah and about three cents a gallon more than the current national average of $4.33.
Dean said increased fuel prices can impact consumers at multiple levels, with the first most notable added expense happening at the pump when they fill up, and then later on increased costs for goods.
“People see higher energy prices close to home and very directly when they pay to heat their homes or fill up on gas,” Dean said. “But those price increases also cycle through the market as added costs for manufacturing and transporting goods, which show up later in price increases on those goods.”
Dean also noted that even with rate hikes on the horizon, overall interest rates were still near historic lows.
Last month, a Deseret News/Hinckley Institute of Politics poll found that inflation was the No. 1 economic concern for Utahns with 50% of respondents rating it as the most pressing fiscal challenge.
A group of Utah business leaders and economists met last week to discuss how ongoing Russian military aggression toward Ukraine, and its related global economic impacts, could impact Utah residents and businesses. Their consensus opinion is that while Utah’s diverse and high performing economy is better situated than most to weather the fallout from the conflict, further increases on the prices of goods and services is a likely scenario.
Contributing: Associated Press