Why the Fed just raised rates

The US Federal Reserve has raised its target interest rate by 25 basis points to 3.75–4.00 per cent, its first increase since 2023. The economics are straightforward: inflation remains too high, while the economy appears strong enough to withstand tighter monetary policy.

The Federal Reserve's target consumer inflation rate is 2%.

Consumer prices rose 3.4 per cent over the year to August. Energy prices were up 16.3 per cent, including a 27.4 per cent rise in gasoline. Core CPI was lower at 2.4 per cent, but the Fed expects its preferred PCE inflation measure to finish 2026 at 3.7 per cent. Meanwhile, unemployment was 4.1 per cent in August and the Fed now expects real GDP growth of 2.3 per cent this year.

That combination gives the Fed room to act. Higher interest rates make borrowing more expensive, restraining household spending and business investment and reducing demand pressure. They cannot produce more oil or reverse an energy shock, but they can reduce the risk that higher energy costs spread into broader prices and wages.

The shift has been building. In July, three FOMC members already wanted rates increased. Now all 12 voting members supported the hike. The Fed’s median projection also puts the federal funds rate at 4.1 per cent at the end of both 2026 and 2027.

The politics are particularly interesting. Chair Kevin Warsh was nominated by President Donald Trump in March and took office in May. Trump wants substantially lower rates and, after the decision, said US interest rates should be 1 per cent or less.

Yet Warsh joined the unanimous vote to increase them.

That illustrates an important feature of the US system. Presidents appoint Fed chairs, subject to Senate confirmation, but Congress has given the Fed operational independence over monetary policy. Warsh is therefore a Trump appointee, not Trump’s representative on interest rates. This decision puts that distinction squarely on display less than two months before the US midterm elections.