A Larger-Than-Normal Fed Rate Hike in December Now Looks More Likely. Here's Why.

Detailed summary

Hotter-than-expected inflation in October means the Fed may raise its target rate by a half percentage point next month.

When it raises interest rates to fight inflation, the Federal Reserve typically moves very gradually, hiking its target rate by a quarter of a percentage point at a time.

But December may be different. That's because, after raising the federal funds rate by a quarter of a percentage point at its September meeting, the Fed's monetary policy committee paused in October to see if inflation was beginning to cool.

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Suddenly, it looks like that was a poor decision. The Consumer Price Index (CPI), the main measure of inflation in the U.S., was just published and showed that inflation was higher than expected in October. The overall price level rose 0.4% month over month, higher than the 0.3% expected and well above the 0.2% level the Fed would like to see.

Higher energy prices, related to the ongoing conflict with Iran, continued to add to overall inflation. But other sectors saw larger-than-expected increases, too, including housing.

As a result, the Fed may have to play catch-up at its last meeting of the year, on Dec. 8-9. That means it could move from its typical quarter-point hike to a half-point hike, which could be jarring for financial markets unused to larger rate increases.

In fact, one Fed official said it out loud. Fed Governor Christopher Waller said on Nov. 10 in a speech in London that a 50-basis-point (bp) hike -- equivalent to half of a percentage point -- is merited. If October's core CPI rate (the rate that excludes volatile food and fuel costs) came in at 0.3% or higher, he said, "I believe a 50-basis-point hike in the policy rate should be considered at the December meeting." And indeed, core CPI in October was 0.3%.

It's not yet clear that Fed Chair Kevin Warsh is on board with a 50 bp hike in December, and…

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