The Federal Reserve raised its benchmark interest-rate target by three-quarters of a percentage point on Wednesday, the largest single increase since 1994, after fresh inflation data showed consumer prices rising 8.6% from a year earlier. The move lifted the federal funds target range to 1.50% to 1.75% and marked a sharp acceleration in the central bank’s effort to restrain demand without tipping an otherwise strong labor market into recession.

The decision followed a Bureau of Labor Statistics report showing that prices rose 1.0% in May alone, with shelter, gasoline and food among the largest contributors. Energy prices were up 34.6% over 12 months and food prices 10.1%, leaving inflation broader and more persistent than policymakers had expected earlier in the year.

A faster move after inflation surprised again

In its policy statement, the Federal Open Market Committee said inflation remained elevated because of pandemic-related supply-and-demand imbalances, higher energy prices and broader price pressures. Officials also pointed to Russia’s invasion of Ukraine and COVID-related lockdowns in China as forces that could keep commodity costs and supply chains under strain.

The three-quarter-point increase represented a change in pace. The Fed raised rates by a quarter point in March and a half point in May. Chair Jerome Powell said at his post-meeting press conference that the committee judged a larger move appropriate after the May inflation report and a separate deterioration in some measures of inflation expectations. He stressed that the central bank’s primary responsibility was to restore price stability, while acknowledging that the path would require slower growth and could bring some softening in labor-market conditions.

The mechanics of the decision were set out in the Fed’s implementation note. The central bank raised the interest rate paid on reserve balances to 1.65%, increased the primary credit rate to 1.75%, and directed the New York Fed’s trading desk to maintain the new 1.50% to 1.75% target range while continuing the balance-sheet runoff that began this month.

Policy projections shift sharply higher

The Fed’s new economic projections show how much the outlook has changed in only three months. In the June projections, the median policymaker expected the federal funds rate to reach 3.4% by the end of 2022, compared with 1.9% in the March projections. The median projection for 2023 rose to 3.8%, implying that officials expect policy to move well above the near-zero setting that prevailed at the start of this year.

At the same time, the committee lowered its median 2022 real GDP growth projection to 1.7% from 2.8% in March and raised the projected year-end unemployment rate to 3.7% from 3.5%. The median estimate for 2022 PCE inflation rose to 5.2%, while core PCE inflation was projected at 4.3%. The combination describes the central challenge facing the Fed: slow spending enough to bring price growth down without causing a severe break in employment.

The broader economy continues to show substantial strength. The latest employment report showed 390,000 jobs added in May and an unemployment rate of 3.6%, near a half-century low. Leisure and hospitality, professional and business services, transportation and warehousing, construction and health care all added jobs. That labor-market resilience gives the Fed more room to tighten, but it also reflects a level of demand that officials increasingly view as inconsistent with restoring inflation to 2%.

Household spending remains strong but purchasing power is under pressure

Consumer demand has not collapsed under rising prices. The Commerce Department’s April income and spending report showed personal consumption expenditures rising 0.9% in current dollars and 0.7% after adjusting for inflation. Spending on both goods and services increased, while the personal saving rate fell to 4.4%.

That pattern is part of why the Fed is focusing on demand. Households are still spending, employers are still hiring, and wage growth remains firm, but inflation is eroding the real value of incomes. Higher interest rates work through the economy by making mortgages, auto loans, business financing and other forms of credit more expensive. The objective is not to reverse supply disruptions directly; monetary policy cannot produce more oil, semiconductors or shipping capacity. Instead, it can reduce the pace at which demand presses against constrained supply.

The immediate effects are already visible in financial conditions. Mortgage rates have risen sharply from their 2021 lows, equity markets have declined, and corporate borrowing costs have increased. Powell said the Fed expects those channels to moderate spending and investment over time. He also said that another increase of either 50 or 75 basis points could be considered at the July meeting, depending on incoming data.

Credibility becomes part of the inflation fight

The June decision carries significance beyond the size of one rate increase. The Fed is trying to prevent high inflation from becoming embedded in household and business expectations. Once consumers and firms begin to assume that rapid price increases will persist, wage setting, contracts and pricing decisions can reinforce inflation even after the original supply shocks fade.

That concern helps explain why policymakers moved more aggressively after the latest inflation report. The central bank’s revised forecasts now contemplate a materially restrictive policy stance and slower economic growth. The tradeoff is increasingly explicit: officials are prepared to accept some cooling in activity in order to reestablish confidence that inflation will return toward the 2% objective.

The next several months will test whether the Fed can accomplish that adjustment while preserving the labor market’s underlying strength. For now, the message from Washington is unmistakable. With inflation at 8.6%, the central bank has shifted from gradual normalization to a faster campaign designed to restrain demand, anchor expectations and restore price stability.