US could take an ultra-step next week

As the inflation rate of the U.S. in August exceeded the market’s outlook, fear of hard-landing is rising. Some even forecast that the Fed will take an ultra-step, raising the interest rate by one percentage point amid elevating concerns for prolonged inflation. There is a fearsome outlook that the interest rate may rise to 4.5 percent early next year.

The Consumer Price Index (CPI) of August, released on Tuesday (local time), increased by 8.3 percent year-on-year, hovering over the market’s outlook of 8.0 percent. The problem is the inflation rate up by 0.1 percent from the previous month despite the downward trend in the global oil prices, dwarfing the previous forecast that U.S. inflation had already peaked.

The Federal Reserve is highly likely to raise the rate by a large margin during the Federal Open Market Committee (FOMC) scheduled for next week. After Fed’s Jackson Hole Economic Symposium last month, several members of the Fed have signaled that the interest rate will reach the 4 percent level early next year. However, Nomura Securities announced that the rate would be in the 4.5-4.75 percent range in February next year due to a high inflation shock.

Considering the U.S.’s current rate is between 2.25 and 2.5 percent, it needs to raise the interest by 2.25 percent in each of the remaining four FOMC meetings by next February. Nomura expects the Fed to take the ultra-step to reach the target rate. “If I had to choose between 100 basis points in September and 50 basis points, I would choose a 100 basis points move to reinforce credibility,” former Treasury Secretary Lawrence H. Summers said on his Twitter account.

The one percentage point increase has never occurred since the 1990s, when the Fed chose the current Federal Fund Rate (FFR) as a tool for monetary policy due to the potential shock the ultra-step may bring to the market. Federal Reserve Chairman Jerome Powell stated that tight monetary policy needs to continue (to control inflation) despite the hardships that households and companies may face, indicating his willingness to risk economic recession. Then, the possibility of ultra-step happening in reality cannot be ruled out.


Hyoun-Soo Kim kimhs@donga.com