The Federal Reserve on Wednesday approved its first interest rate increase in over three years, with officials indicating that another hike may follow, as part of a broader effort to curb inflation driven by surging energy prices and other contributing factors.
In a move that had been widely expected by markets, the Federal Open Market Committee voted 12-0 to raise its benchmark interest rate by 25 basis points, or a quarter percentage point, bringing the overnight funds rate to a target range of 3.75%-4%.
“Inflation remains elevated,” the committee said in its brief post-meeting statement. “Today’s policy action will support a timelier return to the Committee’s 2 percent goal. The Committee will deliver price stability.”
At a subsequent news conference, Chairman Kevin Warsh said inflation has been “too high … for too long.”
“We must be confident that underlying inflation is moving toward our objective clearly and at sufficient speed,” he said. “Today, the FOMC determined that this standard has not yet been satisfied.”
Warsh noted that recent economic data reflected a strong economy, including a robust labor market. However, inflation continued to run above the central bank’s target, and he added that geopolitical tensions in the Middle East also factored into the decision.
“All three of those considerations led to a firm, unanimous decision today,” he said.
Highly Anticipated Move
Despite a series of conflicting statements from policymakers in recent weeks, markets had priced in better than a 90% probability that the FOMC would approve the increase, although there was speculation about the possibility of dissenting votes.
Persistently high inflation readings, combined with comments from Warsh weeks earlier, had convinced Wall Street that the Fed would deliver its first rate hike since July 2023.
Updated projections released Wednesday showed that a strong majority of officials believe another rate increase remains possible before the end of the year.
The dot plot, which reflects individual officials’ rate expectations, indicated that 16 of the 18 participants — Warsh has chosen not to submit a dot since assuming the chairmanship — anticipated another rate increase, with four of those expecting two additional hikes. Two participants expected the committee to limit action to a single hike.
However, no increases are projected for subsequent years, with one rate cut indicated for 2028 and at least one for 2029.
Officials also revised upward their inflation projections for this year.
They now see the headline personal consumption expenditures price index at 3.7% and core inflation excluding food and energy at 3.4%, both 0.1 percentage point higher than the previous update in June. The Fed does not expect to reach its inflation target until 2029, though it projects both measures will decline sharply by 2027 — to 2.3% for headline and 2.5% for core.
The committee had remained on hold throughout the year and was expected to continue doing so, until sentiment began shifting in favor of a hike in late August.
The Fed Rarely Acts Just Once
The Federal Reserve rarely moves only once. Policymakers generally avoid incremental decisions when they believe inflation is too elevated and requires higher rates, or when growth is sluggish and they seek to stimulate demand with lower rates.
While the rate increase was expected, the rationale behind it was unconventional.
The Fed has generally looked through the type of inflation currently visible in the economy, including higher fuel costs linked to the conflict with Iran and the lasting effects of tariffs. However, officials in recent days have weighed the cost of continuing to ignore these price increases, particularly given signs of stabilization in the labor market. The committee lowered its forecast for the unemployment rate to 4.1%, a 0.2 percentage point reduction from June.
The concern now is that prolonged energy prices could entrench higher inflation expectations and begin spreading more broadly across the economy. Economists also point to expanded investment in artificial intelligence as a potential source of inflationary pressure.
Additionally, the “transitory” inflation episode from several years ago remains fresh in policymakers’ minds. Fed officials at the time believed that the supply-and-demand shock from the Covid pandemic would eventually fade. Instead, inflation surged to 40-year highs before the Fed took decisive action.
In July, the policy debate generated significant dissent, with three FOMC members voting against the decision to hold rates steady, preferring instead a quarter-point increase.
At this week’s meeting, expectations for 2027 were closely divided, with eight officials pointing to another hike, six seeing the funds rate remaining steady, and four envisioning cuts.
Markets had already been pricing in higher rates across the curve. The S&P 500 rose following Wednesday’s announcement.
Treasury yields had been climbing steadily. The 10-year note has risen approximately a quarter percentage point since Warsh’s remarks at the Fed’s Jackson Hole, Wyoming, symposium on August 28. The benchmark is up roughly a full percentage point from its February low. The 2-year note, which is most sensitive to rate expectations, has seen even sharper gains.
Borrowing costs have also moved higher. A 30-year fixed rate mortgage had soared to 7.19%, an increase of roughly 38 basis points since the Jackson Hole speech and more than a full percentage point above the level of a year ago, according to Mortgage News Daily.
In the aftermath of the decision, Treasury yields declined, a signal that investors were encouraged by the central bank’s resolve to address inflation. Yields and prices move in opposite directions.
“Today’s FOMC could mark the moment when the committee regained a measure of backbone,” said Brad Conger, chief investment officer at Hirtle & Co. “There were many arguments for standing still. But for once, the committee sided with Main Street.”
“Inflation is a pervasive concern, and its uncertainty is impeding decision-making across all businesses. One swallow doesn’t make a spring, but we might have just caught a glimpse of Volcker-style decisiveness as opposed to the perpetual accommodation of the Powell era,” Conger added.
