Why is the Fed raising interest rates?  And how do these increases slow inflation?

Why is the Fed raising interest rates? And how do these increases slow inflation?

Americans continue to face higher food, gas and rent costs.

While inflation eased slightly in August, it remains elevated. The publication of the Consumer Price Index this month revealed that inflation rose by 8.3% last month compared to the same period last year.

At its last meeting in July, the Fed raised interest rates by 0.75 percentage points to widen the federal funds target range to 2.25% to 2.5% in an effort to curb inflation. It also raised interest rates by 0.75 percentage points in June, representing at the time the largest increase in a single meeting since 1994. A similarly sized hike is expected when the Fed meets again this week in light of a disappointing CPI report from August and strong employment growth that drives wage increases.

But why are increases used to fight inflation and how do they work?

WASHINGTON, DC - JULY 27: Federal Reserve Chairman Jerome Powell pauses during a news conference following a meeting of the Federal Open Market Committee (FOMC) at Federal Reserve Headquarters, July 27, 2022 in Washington, DC.  Powell announced that the Federal Reserve is raising interest rates by three-quarters of a percentage point.  (Photo by Drew Angerer/Getty Images) ORG XMIT: 775845047 ORIG FILE ID: 1242147034

WASHINGTON, DC – JULY 27: Federal Reserve Chairman Jerome Powell pauses during a news conference following a meeting of the Federal Open Market Committee (FOMC) at Federal Reserve Headquarters, July 27, 2022 in Washington, DC. Powell announced that the Federal Reserve is raising interest rates by three-quarters of a percentage point. (Photo by Drew Angerer/Getty Images) ORG XMIT: 775845047 ORIG FILE ID: 1242147034

When will the Fed announce the next rate hike?

The Fed is expected to announce another rate hike by the end of the Federal Open Market Committee meeting on Tuesday, September 20 and Wednesday, September 21. The FOMC is the body within the Fed that decides monetary policy, including interest rates. More committee meetings are scheduled for November and December.

How does a Fed hike work? How does the prime rate affect the 10-year Treasury bond?

As the nation’s central bank, the Federal Reserve is responsible for monetary policy. His dual mandate is to promote “maximum employment and stable prices in the US economy.” Stable prices means keeping inflation under control, with a long-term average annual target of 2%.

In 2020, CPI inflation was 1.4%. In 2021 it was 7%.

One of the Fed’s main tools to influence inflation is the federal funds rate, which is the rate banks charge each other for overnight loans.

Although the Fed does not directly control all interest rates, when it raises the federal funds rate, most other interest rates eventually follow suit, including adjustable-rate mortgages, credit cards, home equity lines of credit, and other loans. Some of them are tied to the prime rate, which is based on the federal funds rate, according to Bankrate.com.

A rising federal funds rate also affects the 10-year Treasury note, which affects mortgages.

Borrowing money then becomes more expensive for consumers, who in turn spend less. Demand begins to decline and inflation, in theory, begins to subside.

Meanwhile, some Americans, especially seniors, are seeing their coffers swelled by higher bank savings rates.

How many times has the Fed raised rates in 2022?

The Fed has raised interest rates four times this year. The shutdown of the economy due to the pandemic had kept interest rates close to zero before the Fed raised rates by 0.25 percentage point in March, the first increase in more than three years.

An additional increase of 0.50 percentage points occurred in May, followed by a historic one A 0.75 percentage point hike in June and then another 0.75 jump in July, putting the rate in its current range of 2.25% to 2.5%.

How much will the Fed raise interest rates?

Economists polled by Bloomberg forecast a third straight increase of 0.75 percentage points this week. That would bring that rate range to 3% to 3.25%. The same economists surveyed predicted that the upper end of the range would reach 4% by the end of the year.

Are rate hikes good for stocks?

Interest rate hikes create volatility in the stock market. The value of future earnings tends to fall when higher interest rates are expected, according to US Bank, making investors less willing to bid on rising stock prices.

Higher interest rates are meant to slow the economy, which can reduce revenue for companies, potentially hurting their growth and stock prices, according to Forbes.

Contributed by: Paul Davidson, Medora Lee

This article originally appeared on USA TODAY: How Fed hikes work and why the Fed is using them to fight inflation

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