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US Fed hikes rates for the first time in 3 years
Key takeaways
- The US Federal Reserve hiked rates by 25 basis points to 3.75%-4.00% this week.
- Persistent above-target inflation and resilient economic growth are expected to lead to further Fed rate hikes.
- The Fed is not the only central bank lifting rates. This week, the Bank of Japan also lifted rates by 25 basis points to 1.25%, the second hike this year.
- While the Bank of England left rates unchanged at 3.75%, a hike at their next meeting in November appears likely.
It is the trend that matters. That was the clear message from new US Fed Chair Warsh this week following the FOMC’s decision to hike rates by 25bps to 3.75%-4.00%. This was the first hike by the Fed in three years and took rates back to levels last seen in early December last year.
The trend that matters most for the Fed is that inflation has remained too high, for too long. Simply put, inflation has been above the Fed’s target for more than five years now. And Chair Warsh and the FOMC have determined that underlying inflation is not “moving to our objective, clearly and at sufficient speed.”
Apart from inflation, Warsh identified a number of other recent trends in his accompanying press conference. The US economy has been resilient given the geopolitical shocks and the “economy appears to be strengthening.” The labour market remains consistent with full employment, so that part of the Fed’s dual mandate “is in good shape.”
Guidance or not, the US Fed expects to hike further
Warsh once again refrained from participating in the FOMC’s so-called dot plot projections, given his strident opposition to any forward guidance. Nonetheless, the latest dots provide insight into the FOMC’s view of the future trends following its unanimous decision to hike this week.
The FOMC projections expect the US economy to continue to expand at a solid pace. The median projection is for real GDP to rise 2.3% over 2026 and 2.4% in 2027, before gradually easing towards trend over 2028 and 2029. The unemployment rate is expected to trend sideways at 4.1%, close to estimates of full employment.
The US core PCE inflation rate is expected to edge up from 3.3% in July 2026 to 3.4% by the end of the year.
While inflation is expected to begin to moderate next year, easing to 2.5% by late 2027, it is not forecast to reach the Fed’s 2% target until 2029.
Reflecting these ongoing inflationary pressures, almost all FOMC participants expect the Fed will need to hike rates a second time in 2026 to 4.125%. Looking ahead to 2027, 8 out of the 18 participants who submitted forecasts expect a third hike will be required, although the median view is for no further hikes in 2027. As inflation moves closer to target, the median participant expects a 25bp rate cut to 3.875% in 2028 and another cut to 3.625% in 2029.
In other words, the trend is for a further increase in policy rates in the US over the coming year. Market pricing is factoring in even more hikes than the Fed, with current federal funds futures peaking over 4.6% in 2027. This implies close to four Fed rate hikes this cycle, including this week's move.
Higher policy rates are not just a US story
The trend towards higher policy rates is not limited to the US. Today, we also saw the Bank of Japan (BoJ) raise rates by a further 25bps to 1.25% following on from their hike in June. Another two to three hikes by the BoJ are expected over the coming year.
As we noted a few weeks ago, we expect the RBA will deliver its fourth hike this year to 4.60% in late September. Comments by RBA Governor Bullock to the House of Representatives Standing Committee on Economics today did little to alter our view after she emphasised that some of the upside risks to inflation that the RBA noted in August “appear to be materialising.”
One central bank that has been slower to shift has been the Bank of England (BoE). This week the BoE left rates unchanged at 3.75%, where they have remained since late 2025. However, the BoE has clearly turned more hawkish with a rate hike looking increasingly likely at their next meeting in November.
With inflation trends becoming more concerning, particularly following the re-escalation of the Middle East conflict over the past couple of months, central banks are beginning to lose their patience. As Governor Warsh emphasised, the shifts we are seeing do not reflect individual data points or a surprise here or there. The shifts reflect the big picture trends. Resilient economic growth. AI boom. Healthy labour market conditions. Ongoing above-target inflation. Even without forward guidance, it is clear these trends are unlikely to shift quickly.
Further monetary policy tightening will be forthcoming. A higher-for-longer interest rate world is here to stay.