Inflation is at a 40-year high. The Fed announced these aggressive moves to fight it

The Federal Reserve raised its key short-term interest rate by a half percentage point Wednesday, its largest hike since 2000, and signaled further big moves may lie ahead as officials scramble to curtail a historic spike in inflation.

"There is a broad consensus (among Fed policymakers) that additional (half-point) rate increases should be on the table at the next couple of meetings," Fed Chair Jerome Powell said at a news conference.

Top economists expect the Fed to lift the rate to a range of 2.25% to 2.5% by the end of the year.

But Powell said Fed officials have no plans to boost rates by three-quarters of a point at any meeting, declaring it's "not something (the Fed's policymaking committee) is actively considering." Economists had speculated such a scenario was possible.  

Stocks rallied after Powell's comment. The Dow Jones Industrial Average closed 933 points higher, or 2.8%, making it the largest one-day gain since November 2020. The S&P closed up 3% while the tech-heavy Nasdaq Composite grew by 3.2%.

The central bank also said it will begin shrinking its $9 trillion in bond holdings next month, a strategy that will nudge long-term interest rates higher.

Wednesday’s hike, which was widely expected, boosts the Fed’s benchmark rate from a range of 0.25% to 0.5% to a range of 0.75% to 1%.

WHAT'S IT MEAN FOR ME? How Fed's bigger, faster rate hikes will affect your credit card, mortgage, savings rates

INVESTING IN A RECESSION:As odds rise for a recession, what's your investment strategy?

TURBOTAX SETTLEMENT:Intuit to pay $141 million for false promises of free filing

It’s expected to set off a domino effect through the economy, pushing up rates for credit cards, home equity lines of credit and adjustable-rate mortgages, among other loans. At the same time, Americans, particularly seniors, should start to benefit from higher bank savings rates after years of negligible returns.

While Powell said officials are not considering a three-quarter point hike at any given meeting, he made clear the Fed won't hesitate to lift rates sharply through the year to tame inflation. He said policymakers plan to move "expeditiously" to return the Fed's key rate to the 2.25% to 2.5% range considered "neutral" because it theoretically would neither juice nor dampen economic growth. Economists believe the Fed will reach that level by year's end.

But if the Fed needs to hike further, achieving a "restrictive" rate that would crimp growth in order to bring down inflation, "We will not hesitate to go that level," Powell said.

In a statement after a two-day meeting, the Fed acknowledged the economy contracted early in the year but said it's still fundamentally strong. 

"Job gains have been robust in recent months, and the unemployment rate has declined substantially," the Fed said.

And it underscored its vigilance about rising prices.

Besides Russia's war in Ukraine, the Fed noted that "COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is highly attentive to inflation risks."

The Fed hikes rates to curb borrowing, cool off an overheated economy and fend off inflation spikes. It lowers them to spur borrowing, economic activity and job growth.

Early in the pandemic, amid unprecedented business closures and layoffs, the Fed slashed its federal funds rate to zero and launched massive bond purchases to lower long-term rates.

Now, however, the Fed is combatting sky-high inflation even as growth is slowing from last year’s robust 5.7% pace. That marked a 37-year high as vaccinations increased and the economy reopened.

The unusual dynamic is stoking worries that rapid Fed rate hikes could tip the economy into recession.

Powell, however, noted that demand in the economy is so far outpacing supply that the Fed should be able to scale back demand without triggering a recession. He noted there are a record 1.9 job openings for every unemployed American.

"There should be room to reduce the surplus demand without putting people out of work," he said. "It's a strong economy. Nothing about it says it's close to ... recession."

BITCOIN IN YOUR NEST EGG? Fidelity plans to offer Bitcoin in its 401(k) retirement funds. But is it best for you?

The Fed has consistently underestimated inflation’s staying power, forcing policymakers to repeatedly ramp up their rate hike plans. As recently as early November, Fed officials were calling inflation a “transitory” byproduct of an economy recovering from the COVID-19-induced recession and related supply chain bottlenecks.

By December, they acknowledged price increases were more persistent than they thought and forecast three rate increases in 2022, up from one in their September outlook. That would bring the rate to about 0.9% by year’s end.

In March, with inflation heating up further amid the Russia-Ukraine war, the Fed lifted its key rate – by a quarter-point from near zero – for the first time in more than three years. It also revised upward its year-end rate estimate to 1.9%.

Now, the Fed is revamping its playbook again, with economists predicting a federal funds rate of about 2.4% by December and warning a higher rate is possible.  

Behind the aggressive approach is annual inflation that reached a new 40-year high of 8.6% in March. Economists blame the supply snarls, pandemic-related worker shortages that have boosted wages and strong consumer demand heightened by federal stimulus money.

IS INFLATION BIDEN'S FAULT? Biden's $1.9T stimulus caused inflation, critics say. But others argue it saved the economy.

Total employee compensation surged by a 32-year high of 1.4% in the first quarter, the Labor Department said, intensifying fears of a wage-price spiral that could be difficult to control.

"We can't run that risk," Powell said.

And hiring has been stronger than anticipated. Employers added an average of 562,000 jobs a month from January to March as more than 2 million Americans streamed back into a favorable labor market with record job openings. The unemployment rate is at 3.6%, just above the 50-year low it reached before the pandemic.

That has stirred fears of further wage and price increases and bolstered the Fed’s belief that the economy is healthy enough to withstand large rate hikes.

FEARING THE RATE HIKE?:9.6% inflation-protected I Bonds could be a saving grace

The government said last week the economy unexpectedly contracted by 1.4% in the first quarter. But the poor showing was traced to weaker inventory building and a widening trade deficit, both of which are volatile. Consumer and business spending – the core of the economy -- notched solid gains.

At the same time, many economists believe inflation has peaked, with supply snags starting to ease and a growing labor force easing wage pressures. That could lessen the need for the Fed to continue to lift rates dramatically later this year.

Powell, though, said the Fed won't ease off rate increases until it's confident "inflation is under control and starting to come down."

The central bank on Wednesday also said it will begin shedding the trillions of dollars in Treasury bonds and mortgage-backed securities it has amassed. The purchases ballooned the Fed's balance sheet to about $9 trillion.

Rather than sell the bonds outright, which could disrupt markets, the Fed plans to gradually trim its holdings by not reinvesting the proceeds from some of the assets as they mature.

The Fed said it would reduce the Treasury bonds in June by up to $30 billion and the mortgage securities by up to $17.5 billion, ramping up those levels to $60 billion and $35 billion, respectively, within three months. Fed officials also have discussed the possibility of selling the assets to diminish its balance sheet more quickly if necessary.

The shrinking holdings should nudge mortgage and other long-term rates higher over the next few years.

Contributing: Elisabeth Buchwald