Fed raises key interest rate by 0.75% as it battles inflation

The Federal Reserve said on Wednesday that it is raising its benchmark interest rate by three-quarters of a percentage point, the sharpest hike since 1994, as it seeks to combat the fiercest surge in U.S. inflation in four decades.

The U.S. central bank set its target rate in the range of 1.5 to 1.75%. The federal funds rate, which controls how much banks pay to borrow money from each other, affects borrowing costs for consumers and businesses.

The Fed had previously suggested it was likely to boost rates by half a percentage point at each of its three meetings this year, but recent signals that inflation is accelerating spurred policymakers to move more aggressively to slow economic growth in a bid to tame prices.

"The labor market is extremely tight, and inflation is much too high," Federal Reserve Chairman Jerome Powell said in a press conference Wednesday.

"My colleagues and I are acutely aware that inflation poses acute hardship, especially to those least able to meet their basic needs," he said.

Powell said the Fed is likely to continue raising rates, in increments of 0.5% or 0.75%, as it tries to tamp down demand for labor. Cooling the job market should reduce wage growth, helping to mute price increases, Powell said.

In raising interest rates, the Federal Open Markets Committee noted in its policy statement that Russia's war in Ukraine and ongoing supply-chain struggles are "creating additional upward pressure on inflation and are weighing on global economic activity." In addition, "COVID-related lockdowns in China are likely to exacerbate supply chain disruptions," the committee said.

The Fed expects inflation to gradually fade this year, although less slowly than it previously forecast. Policymakers project that personal consumption expenditures — the Fed's preferred inflation gauge — will decline to 5.2% by year-end, 2.6% in 2023 and 2.2% in 2024.

The Fed has rapidly shifted this year from propping up the economy during the pandemic to trying to choke off a surge in consumer prices, which have been rising at the fastest rate since the 1980s.

The economy has slowed sharply this year, shrinking 1.4% in the first quarter amid a drop in U.S. exports and reduced federal spending. The Fed expects the nation's gross domestic product to expand 1.7% this year and in 2023 as higher interest rates act as a brake on economic activity.

Economic growth remains solid, with unemployment near a 50-year low of 3.6% and businesses continuing to hire. But the steepest inflation since 1981 is hitting households hard and causing consumer spending to shrink, with the government reporting that retail sales fell in May. The 0.3% decline, the first such drop since December, is a sign that high gas prices may be forcing consumers to spend less on other purchases.

Last week, a sentiment survey by the University of Michigan found that Americans' expectations for future inflation are rising, a worrisome sign for the Fed because expectations can become self-fulfilling.

This is a developing story. The Associated Press contributed reporting.