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Federal Reserve will taper bond purchases, hike interest rates more aggressively in 2022

Citing higher-than-expected inflation and supply-chain problems, the central bank noted it would more quickly and drastically hike interest rates and pare back its bond-buying programs.

WASHINGTON (CN) — After months of promising investors that inflation would be only transitory, then finally acknowledging it would raise interest rates and ease its bond-buying programs, the Federal Reserve announced Wednesday it would move more aggressively on both fronts to combat persistent inflation.

The move heralds an adjustment to the central bank's goal of achieving “maximum employment” and 2% inflation over a longer duration to contend with “supply and demand imbalances related to the pandemic,” as well as growth due to the economy reopening.

“With inflation having exceeded 2% for some time, the committee expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the committee’s assessments of maximum employment,” the Federal Open Markets Committee said.  

And though the statement contained much of the boilerplate language the Fed has included in the last several releases, it was notable for eliminating the word “transitory” when describing recent price hikes and instead calling inflation “elevated.”

In its economic projections, issued alongside the announcement, the Fed increased its inflation outlook for this year from 5.3% from 4.2%, while it now expects headline inflation to hit 2.6% next year. Conversely, the Fed predicts unemployment will drop in 2022 to 4.3%, which is half a percentage point lower than the central bank forecast in September.

According to the projections, none of the FOMC’s 18 members think the central bank will keep the federal funds interest rates at the historically low 0% to 0.25%, while two-thirds of the members predict at least three interest rate hikes in 2022.

The Fed projects a median interest rate of 0.9% in 2022, 1.6% in 2023, and 2.1% in 2024. The highest the FOMC members predict the central bank would hike interest rates to next year is 1.1%, while no member thinks the central bank would raise rates lower than 0.4% in 2022.

“Economic developments and changes in the outlook warrant this evolution of monetary policy, which will continue to provide appropriate support for the economy,” Fed Chair Jerome Powell said to reporters following the announcement.

Powell in particular cited the supply-chain issues as the reason behind the change. “These problems have been larger and longer lasting than anticipated, exacerbated by waves of the virus,” he said. “While the drivers of higher inflation have been predominately connected to the dislocations caused by the pandemic, price increases have now spread to a broader range of goods and services.”

The Fed, which was set to taper off its bond buying this month, will starting in January buy only $60 billion in Treasuries and mortgage-backed securities. The FOMC predicts it will green light similar $30 billion monthly reductions in February and March.

The central bank noted it would take into account “public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments” when adjusting monetary policy later in 2022, stressing that “the path of the economy continues to depend on the course of the virus.” Inflationary data in recent weeks have shown decades-high price hikes among many sectors, most notably energy and vehicles.

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