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

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Americans still face higher food, gas and rent costs.

while inflation eased a little in August, it remains elevated. The publication of the Consumer Price Index this month showed that inflation rose by 8.3% last month compared to the same time last year.

At its last meeting in July, the Fed raised interest rates by 0.75 percentage points to raise the federal funds target to 2.25% to 2.5% in a bid to curb inflation. It also raised interest rates by 0.75 percentage point in June, which then corresponded to the largest increase in one meeting since 1994. A similar-sized gain is expected as the Fed reconvenes this week in light of the disappointing August CPI report and strong job growth propelling wage growth.

But why are interest rate hikes used to fight inflation, and how do they work?

WASHINGTON, DC – JULY 27: Jerome Powell, chairman of the United States Federal Reserve Board, pauses during a news conference after a meeting of the Federal Open Market Committee (FOMC) at the 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: 124214734

When will the Fed announce the next rate hike?

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

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How Does a Fed Raise Work? How does it affect the prime rate, 10-year Treasury bonds?

As the country’s central bank, the Federal Reserve is responsible for monetary policy. It’s double mandate is to promote “maximum employment and stable prices in the US economy”. Stable prices mean that inflation needs to be kept under control, with a long-term target of 2% annualized on average.

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

One of the Fed’s primary tools for influencing inflation is the federal funds rate, the rate that banks charge each other for short-term loans.

While the Fed doesn’t directly monitor all interest rates, most other interest rates will eventually follow when it raises federal funds rates, including variable-rate mortgages, credit cards, equity lines of credit, and other loans. Some of these are tied to the prime rate, which is based on the federal funds rate, according to Bankrate.com.

Rising federal fund rates also affect the 10-year Treasury bond, affecting mortgages.

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

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

How many times has the Fed raised interest rates in 2022?

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

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An additional 0.50 percentage point increase followed in May, followed by a historic An increase of 0.75 percentage point in June and then another increase of 0.75 in July, bringing yields to their current range of 2.25% to 2.5%.

How much will the Fed raise interest rates?

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

Are interest rate hikes good for stocks?

Interest rate hikes create volatility in the stock market. The value of future income tends to fall when higher interest rates are expected, according to US Bank, making investors less likely to increase stock prices.

Higher interest rates are intended to slow the economythat can hinder revenues for businesses, potentially damaging to their growth and stock prices, according to Forbes.

Contributors: Paul Davidson, Medora Lee

This article originally appeared on USA TODAY: How Fed Raises Work and Why the Fed Is Using Them to Fight Inflation?

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