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Federal Reserve officials say they might need to raise interest rates sooner than expected

Federal Reserve officials have said they might need to raise interest rates sooner than expected to keep inflation from spiraling out of control - as the US economy continues to grow at lightning speed. 

Federal Reserve Chairman Jerome Powell said in a press conference Wednesday officials now expect to hike the interest rate from near zero to 0.6 percent by the end of 2023.

Back in March, the central bank said it didn't expect to raise it until at least 2024. 

The interest rate affects both consumer and business loans, impacting everything from credit cards to mortgages. 

When the rate set at near zero, borrowing costs are cheap and money 'floods' the system. This helps to goose growth, but also can send prices spiraling out of control.

With the economy recovering more rapidly than anticipated from the COVID-19 pandemic, consumer prices soared at a faster rate in May than any time since the Great Recession.  

Last week, the government warned that overall consumer prices rose 0.6 percent in May, bringing the annual inflation rate to 5 percent - the highest level since August 2008. 

Federal Reserve Chairman Jerome Powell (above) said in a press conference Wednesday they now expect to hike the interest rate from near zero to 0.6 percent by the end of 2023

Inflation in the US rose at a faster rate in May than any time since the Great Recession, data last week showed

The updated interest rate projection comes as the Federal Reserve attempts to put a brake on such out-of-control prices.  

A majority of 11 of 18 Fed officials pencil in at least two quarter-percentage-point rate increases for 2023, even as officials pledged in a statement to keep policy supportive for now to encourage an ongoing jobs recovery. 

Meanwhile, overall economic growth is expected to hit 7 percent this year   

The Fed cited the vaccine rollout and its role in the nation's economic recovery, dropping a long-standing reference that the crisis was weighing on the economy. 

'Progress on vaccinations has reduced the spread of COVID-19 in the United States' the Fed said in its statement, a substantial shift for an institution that has conditioned policy for the past 14 months on battling the pandemic. 

Powell also told reporters, at the end of a two-day policy meeting, that officials started 'talking about talking about' tapering the central bank's $120 billion in monthly asset purchases, which officials said would continue until 'substantial further progress' has been made toward the central bank's maximum employment and 2 percent inflation goals.

'In coming meetings, the committee will continue to assess the economy's progress toward our goals,' Powell said, referring to the policy-setting Federal Open Market Committee.

He declined to offer guidance on the timing for any future policy shift, emphasizing that more economic progress is needed before the 'substantial further progress' standard is met.

Powell also made it clear the central bank would communicate with markets and the public before making a policy shift. 

Following the news, stocks immediately went lower and bond yields higher (pictured the Dow Jones dipped) 

'We will provide advance notice before announcing any decision to make changes to our purchases,' he said.   

The dollar jumped to a near six-week high Wednesday following the revised projection about the interest rate hikes. The dollar index, which tracks the greenback against six major currencies, was up 0.63 percent at 91.103, its highest since May 6.  

'The interesting thing is that the Fed has gone beyond simply acknowledging that inflation is rising and that the U.S. economy has a lot of momentum, and it has essentially shifted to a much more hawkish stance in this set of projections,' said Karl Schamotta, chief market strategist at Cambridge Global Payments in Toronto.

Against the Japanese yen, the dollar rose 0.39 percent to 110.49 yen, its highest since April 6.

The dollar, which slumped through much of 2020, staged a rebound earlier this year, but that relief rally appeared to run out of steam through May as investors remained convinced that the Fed will keep interest rates lower for longer as it seeks to support the economy.

While the Fed's new language does not mean a change in policy is imminent it does provide more support for the greenback, analysts said.

With the economy recovering more rapidly than anticipated from the COVID-19 pandemic, consumer prices are soaring, the government revealed last week. A higher interest rate could balance this

Inflation saps the value of your dollar: This is how it works 

Have you ever been shopping and noticed that the prices of things you typically buy have gone up? If the items in your shopping basket cost $100 last year and now they cost $105, at a very basic level, that's inflation. 

Prices are changing all the time but we don't say there is inflation every time we see a price increase. 

Instead, we say there is inflation when the prices of many of the things we buy rise at the same time and then continue to rise.  

So how can we tell when inflation is happening and by how much? We do so by looking at the prices of many items over time. 

Government statistical agencies regularly gather information about the prices of thousands of goods and services. 

They then organize the prices into categories such as 'transportation' and 'apparel,' they combine the prices in each category, and they report the results in various price indexes.

Price indexes are just collections of prices. 

For example, some indexes contain the prices of items that consumers buy, and others contain the prices of items that businesses buy. 

Others contain prices only for goods, while others contain prices only for services, and so on. 

If the level of an index is higher now than it was a month or year ago, it tells us that the prices contained in that index are higher on average, which tells us there is inflation.

Source: Federal Reserve Bank of Cleveland

'I think we're back to talking about a mild rally in the US dollar and the data becoming very important over the summer period prior to Jackson Hole and September's meeting,' said Simon Harvey, senior FX market analyst at Monex Europe.

Risk-sensitive currencies logged a sharp reversal following the Fed announcement, with the New Zealand dollar down 0.98 percent at $0.7049 and the Australian dollar - which is seen as a proxy for risk appetite - up 0.95 percent at $0.7612.

Sterling, which had strengthened against the dollar on Wednesday after data showed British inflation unexpectedly jumped above the Bank of England's 2 percent target in May, gave up those gains to trade down 0.49%.

Meanwhile, bitcoin's recent rally appeared to run out of steam, as the world's largest cryptocurrency fell 4.34 percent to $38,430.03.

Wall Street was also impacted by the interest rate announcement.

Right now, the money the Fed is providing is helping to fuel investments into the stock market as people chase returns with money gotten on the cheap.   

But the moves moderated as the Fed's chair, Jerome Powell, said in a press conference that any changes are likely still a way away.

It had been down as many as 382 points shortly after the Fed's announcement.  

In the bond market, the yield on the 10-year Treasury climbed to 1.54 percent from 1.50 percent late Tuesday. 

The two-year yield, which moves more closely with expectations for Fed policy, rose to 0.20 percent from 0.16 percent.

Last week, the government released its monthly report showing core inflation, which excludes volatile energy and food costs, rose 0.7 percent in May.

This came after an even bigger jump in April, and is up 3.8 percent over the past 12 months - the quickest rise since 1992.

This rise in inflation means a spike in costs to Americans in the goods they buy and services they use. 

Deutsche Bank issued a warning off the back of the report that the hike in inflation will 'touch everyone'. 

'The effects could be devastating, particularly for the most vulnerable in society,' it said.

'Few still remember how our societies and economies were threatened by high inflation 50 years ago. 

'The most basic laws of economics, the ones that have stood the test of time over a millennium, have not been suspended,' the bank's report warned.

People walk through a shopping area in Manhattan last week. The reopening surge is driving prices higher for consumers

Shoppers in California in May. The Fed cited the vaccine rollout and its role in the nation's economic recovery as a need to bring forward the interest rate hike 

The report expressed concerns that huge deficit spending by Congress as well as the Federal Reserve's loose monetary policy could supercharge inflation rates.

'The current fiscal stimulus is more comparable with that seen around WWII' when deficits ran 15 to 30 percent of GDP for four years, the report said. 

'While there are many significant differences between the pandemic and WWII we would note that annual inflation was 8.4%, 14.6% and 7.7% in 1946, 1947 and 1948 after the economy normalized and pent-up demand was released.'

'Monetary stimulus has been equally breath-taking,' the report added of the Federal Reserve, which has flooded the economy with money through bond purchases. 

'In numerical terms, the Fed's balance sheet has almost doubled during the pandemic to nearly $8 trillion. That compares with the 2008 crisis when it only increased by a little more than $1 trillion, and then increased another $2 trillion in the subsequent six years.' 

'We worry that inflation will make a comeback,' the report concluded. 'An explosive growth in debt financed largely by central banks is likely to lead to higher inflation.'  

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