US Fed chief Powell warns higher rates may tip economy into recession

The chief of the US Federal Reserve has warned it may hike interest rates to a level that tips the economy into a recession.

“It’s certainly a possibility” that a rapid tightening of monetary policy will force the US economy into reverse, Fed chair Jerome Powell said today in response to a grilling by American lawmakers.

The Fed last week lifted borrowing costs 75 basis points, the steepest since 1994, in a bid to cool demand to rein in the highest inflation since the 1980s.

Prices unexpedly leapt 8.6 per cent annually last month, much higher than Wall Street’s forecasts.

Powell signalled further steep rate rises are not off the table.

The federal funds rate, now at between 1.5-1.75 per cent, “is still at a relatively low level,” he said, adding “we want to get it to a more neutral-ish level even more expeditiously.”

“We anticipate that ongoing rate increases will be appropriate.” 

How do interest rates work?

Higher interest rates, in theory, weigh on household spending by making it more expensive to borrow money and more attractive to save.

The Fed’s rate exerts a strong influence on yields on 10-year US Treasuries, which are also used to calculate mortgage costs.

Higher mortgage rates tamp down on demand in the housing market, which can reduce property prices, making Americans feel worse off and more cautious.

Lower demand in an economy reduces inflation by forcing businesses to slash prices to sell goods and services.

Weaker demand means firms curb hiring or cut staff numbers as they do not need to produce the same volume of products, resulting in higher unemployment. This joblessness spike also weighs on spending on the overall price level in an economy.

Other central banks are following the Fed’s lead. The Bank of England has lifted rates at each of its last five meetings, taking them to a 13-year high of 1.25 per cent, as it chases a four decade high inflation level of 9.1 per cent. 

The Bank is expected by markets to hike rates again at its next meeting on 4 August.