Despite Cooling Inflation, the Fed Is Raising Interest Rates Yet Again

That's not great news for borrowers or the economy in general.

November's Consumer Price Index (CPI) report, which was released on Dec. 13, contained some positive news. The CPI only rose by 7.1% on an annual basis. And while that's a much higher annual increase than normal, it's far less substantial than October's 7.7% CPI increase.

In fact, annual CPI increases have been declining since the summer, and that's an indication that the issue of inflation is finally beginning to resolve itself. And recently, the Federal Reserve pledged to slow down its interest rate hikes in light of cooling inflation.

Technically, it kept its promise. Prior to its most recent meeting, the Fed had raised interest rates by 0.75% four times in a row. During its Dec. 14 meeting, it announced a 0.5% interest rate hike. But to be clear, that's still a pretty sizable rate hike. And it's also the seventh one the Fed has implemented this year. 

Unfortunately, persistent rate hikes could spell bad news for consumers. And they could also lead to a period of general economic upheaval.

The problem with interest rate hikes

The Federal Reserve isn't in charge of setting consumer borrowing rates, like mortgage rates and credit card rates. But when the Fed raises interest rates, it indirectly drives up the cost of consumer borrowing.

Before this most recent rate hike, consumers were already looking at higher-than-average costs across a range of borrowing products. Now, they'll need to gear up for even higher interest rates on products like auto and personal loans. And that could easily lead to a major decline in spending.

That's actually what the Fed wants, though. The whole point of raising interest rates has been to slow the pace of inflation. And the reason inflation has soared over the past 18 months is that consumer demand has exceeded the availability of goods. So if consumers get fed up with higher borrowing rates and decide to start spending less, it should bridge that gap, thereby allowing inflation to cool even more.

The problem with the Fed's approach, though, is that it assumes it will achieve its desired soft landing -- a moderate pullback in consumer spending that helps solve the problem of inflation. What might happen instead is that consumer spending declines to a major degree, thereby fueling a recession within the next 12 months to 24 months. 

Will interest rate hikes persist into 2023?

That will largely depend on how things shake out from an inflation standpoint. If the CPI keeps following its recent pattern, then the Fed may choose to ease up on rate hikes in the new year. But if the Fed remains unhappy with the state of inflation, it will likely continue to raise interest rates until the cost of living declines in a meaningful way.

Will that spur a full-blown recession? Maybe. That's a risk the Fed knows it's taking. But clearly, the Fed feels it has no choice but to keep raising rates, so it won't be shocking to see rate hikes continue well into the new year.