Inflation Reports Raise Chances for Surprise 0.75-Percentage-Point Rate Rise This Week

Two consumer surveys have also shown households’ expectations of future inflation have increased in recent days. That data could alarm Fed officials because they believe such expectations can be self-fulfilling.

The Fed raised rates by a half-percentage point at its meeting last month, the first such increase since 2000, to a range between 0.75% and 1%. The Fed last raised rates by 0.75 percentage point at a meeting in 1994, when the central bank was rapidly raising rates to pre-empt a potential rise in inflation.

Fed Chairman

Jerome Powell

has avoided surprising markets on the day of policy meetings, instead arguing that the central bank can achieve its goals of tightening policy by shaping market expectations.

But he also said in an interview last month that the Fed would be guided by the economic data to come. “What we need to see is clear and convincing evidence that inflation pressures are abating and inflation is coming down. And if we don’t see that, then we’ll have to consider moving more aggressively,” Mr. Powell said.

At a press conference last month, Mr. Powell said the central bank would “strive to avoid adding uncertainty” but also acknowledged the possibility of “further surprises” in the inflation data. “We therefore will need to be nimble in responding to incoming data and the evolving outlook,” he said.

The Labor Department reported Friday that its consumer-price index rose 8.6% in May from the same month a year ago, pushing inflation to a new 40-year high. That was a setback for forecasters who were looking for signs that inflation had peaked in March. Rising fuel prices and supply-chain disruptions from Russia’s war against Ukraine have sent prices up in recent months.

A handful of Wall Street forecasters, including at investment banks

Barclays

and Jefferies, said Friday, after the inflation data were released, that they expected the Fed to raise rates by 0.75 percentage point this week.

“We believe that risk-management considerations call for aggressive action to reinforce the Fed’s inflation-fighting credibility,” Barclays economists wrote in a subsequent report Monday. While such a move “would go against communications leading into the blackout period,” the report said “risks of prolonged inflation have intensified,” justifying the larger rate rise.

On Friday, a University of Michigan survey of consumers’ long-term inflation expectations rose to its highest level since 2008. On Monday, the New York Fed reported that its survey showed consumers’ short-term inflation expectations had jumped and that the distribution of households’ longer-term expectations was more varied than in the past, suggesting more households may be expecting higher inflation to stay, even though the median didn’t rise.

Fed officials have said they would want to respond aggressively to signs that inflation expectations were rising, or becoming “de-anchored,” because they believe the process of wringing inflation from the economy will become far more difficult if that has happened.

“It’s a one-two punch,” said

Diane Swonk,

chief economist at Grant Thornton. “They’ve got to go now with 75. The Fed is behind the curve, and they know it.”

Bond yields, which surged Friday amid a broad market selloff, continued to climb as that rout deepened on Monday. Investors in interest-rate futures markets placed a nearly 30% probability on the larger 0.75-percentage-point increase on Monday afternoon, up from around 4% before last Friday’s inflation reports.

Officials will have to weigh several considerations at their two-day meeting that begins on Tuesday. They could stick with their current strategy of raising rates in half-percentage-point increments indefinitely until they see signs that inflation is conclusively downshifting.

Such a path of rate rises would lift the Fed’s overnight benchmark rate to a range between 2.25% and 2.5% by September, and to a range between 3.25% and 3.5% by December. This would represent the most aggressive interval of policy tightening since the 1980s.

Alternatively, Mr. Powell and his colleagues could signal a rising likelihood of shifting to larger rate rises at the Fed’s meeting in late July.

But if officials anticipate a significant likelihood of such an increase at the July 26-27 meeting, they could decide to move more aggressively this week.

Ms. Swonk said she expected officials to make such an argument at this week’s meeting. “The data now is not good. The data is saying they have to do more,” said Ms. Swonk. “We’re moving into a more inflation-prone world, and they know that, and if they don’t derail it now, this could be incredibly corrosive.”

Already, borrowing costs set by markets have climbed faster than the Fed’s benchmark rate in anticipation of its policy moves. Mortgage lenders on Monday said they were beginning to quote a 30-year fixed loan with rates above 6%, levels that haven’t been reached since 2008.

Fed officials have other devices to underscore a more aggressive posture, including in new rate and economic projections to be released Wednesday. Mr. Powell will elaborate on the rate outlook at his press conference later that day, and he is set to testify in Congress next week.

Write to Nick Timiraos at [email protected]

Two consumer surveys have also shown households’ expectations of future inflation have increased in recent days. That data could alarm Fed officials because they believe such expectations can be self-fulfilling.

The Fed raised rates by a half-percentage point at its meeting last month, the first such increase since 2000, to a range between 0.75% and 1%. The Fed last raised rates by 0.75 percentage point at a meeting in 1994, when the central bank was rapidly raising rates to pre-empt a potential rise in inflation.

Fed Chairman

Jerome Powell

has avoided surprising markets on the day of policy meetings, instead arguing that the central bank can achieve its goals of tightening policy by shaping market expectations.

But he also said in an interview last month that the Fed would be guided by the economic data to come. “What we need to see is clear and convincing evidence that inflation pressures are abating and inflation is coming down. And if we don’t see that, then we’ll have to consider moving more aggressively,” Mr. Powell said.

At a press conference last month, Mr. Powell said the central bank would “strive to avoid adding uncertainty” but also acknowledged the possibility of “further surprises” in the inflation data. “We therefore will need to be nimble in responding to incoming data and the evolving outlook,” he said.

The Labor Department reported Friday that its consumer-price index rose 8.6% in May from the same month a year ago, pushing inflation to a new 40-year high. That was a setback for forecasters who were looking for signs that inflation had peaked in March. Rising fuel prices and supply-chain disruptions from Russia’s war against Ukraine have sent prices up in recent months.

A handful of Wall Street forecasters, including at investment banks

Barclays

and Jefferies, said Friday, after the inflation data were released, that they expected the Fed to raise rates by 0.75 percentage point this week.

“We believe that risk-management considerations call for aggressive action to reinforce the Fed’s inflation-fighting credibility,” Barclays economists wrote in a subsequent report Monday. While such a move “would go against communications leading into the blackout period,” the report said “risks of prolonged inflation have intensified,” justifying the larger rate rise.

On Friday, a University of Michigan survey of consumers’ long-term inflation expectations rose to its highest level since 2008. On Monday, the New York Fed reported that its survey showed consumers’ short-term inflation expectations had jumped and that the distribution of households’ longer-term expectations was more varied than in the past, suggesting more households may be expecting higher inflation to stay, even though the median didn’t rise.

Fed officials have said they would want to respond aggressively to signs that inflation expectations were rising, or becoming “de-anchored,” because they believe the process of wringing inflation from the economy will become far more difficult if that has happened.

“It’s a one-two punch,” said

Diane Swonk,

chief economist at Grant Thornton. “They’ve got to go now with 75. The Fed is behind the curve, and they know it.”

Bond yields, which surged Friday amid a broad market selloff, continued to climb as that rout deepened on Monday. Investors in interest-rate futures markets placed a nearly 30% probability on the larger 0.75-percentage-point increase on Monday afternoon, up from around 4% before last Friday’s inflation reports.

Officials will have to weigh several considerations at their two-day meeting that begins on Tuesday. They could stick with their current strategy of raising rates in half-percentage-point increments indefinitely until they see signs that inflation is conclusively downshifting.

Such a path of rate rises would lift the Fed’s overnight benchmark rate to a range between 2.25% and 2.5% by September, and to a range between 3.25% and 3.5% by December. This would represent the most aggressive interval of policy tightening since the 1980s.

Alternatively, Mr. Powell and his colleagues could signal a rising likelihood of shifting to larger rate rises at the Fed’s meeting in late July.

But if officials anticipate a significant likelihood of such an increase at the July 26-27 meeting, they could decide to move more aggressively this week.

Ms. Swonk said she expected officials to make such an argument at this week’s meeting. “The data now is not good. The data is saying they have to do more,” said Ms. Swonk. “We’re moving into a more inflation-prone world, and they know that, and if they don’t derail it now, this could be incredibly corrosive.”

Already, borrowing costs set by markets have climbed faster than the Fed’s benchmark rate in anticipation of its policy moves. Mortgage lenders on Monday said they were beginning to quote a 30-year fixed loan with rates above 6%, levels that haven’t been reached since 2008.

Fed officials have other devices to underscore a more aggressive posture, including in new rate and economic projections to be released Wednesday. Mr. Powell will elaborate on the rate outlook at his press conference later that day, and he is set to testify in Congress next week.

Write to Nick Timiraos at [email protected]