On Thursday, stock markets buckled on the growing realization that the Fed may be willing to let the economy slide into recession if it decides thats whats needed to drive inflation back down to its 2% annual target.

The S&P 500 stock index lost roughly 100 points  2.5% in its worst day since early November. The losses came a day after the Fed raised its benchmark interest rate for the seventh time this year. The half-point hike the Fed announced to a range of 4.25% to 4.5% had been widely expected.

What spooked investors was Wall Streets growing understanding of how much further the Fed seems willing to go to defeat high inflation. In updated projections they issued Wednesday, the Feds policymakers forecast that they will ratchet up their key rate by an additional three-quarters of a point to a hefty 5% to 5.25% and keep it there through 2023. Some Fed watchers had expected only an additional half-point in rate hikes.

Those higher rates will mean costlier borrowing costs for consumers and companies, ranging from mortgages to auto and business loans.

The policymakers also downgraded their outlook for economic growth in 2023 from the 1.2% they had forecast in September to a puny 0.5% as near to a recession forecast as they were likely to make. Whats more, they raised their expectation for the unemployment rate next year to 4.6% from 3.7% now.

All of which suggested that the officials expect or at least would accept an economic downturn as the price of taming inflation.

The message the Fed was sending, said Ryan Sweet, chief U.S. economist at Oxford Economics, was blunt: Were going to break something. Were going to break inflation or were going to break the economy.

Many investors had convinced themselves that with inflation pressures gradually easing, the Fed might soon declare some progress in their fight and perhaps even reverse course and cut rates sometime in 2023.

There was seemingly reason for optimism: Consumer prices rose 7.1% last month from a year earlier, down from 9.1% in June and the fifth straight drop. Even more encouragingly, on a month to month basis, prices inched up just 0.1%. And core inflation, which excludes volatile food and energy costs and which the Fed tracks closely, rose just 0.2% from October to November, the mildest rise since August 2021.

A slowing economy has eased pressure on supply chains, which had previously been overwhelmed with customer orders, causing shortages, delays and higher prices. Oil prices, too, have plunged, easing prices at the pump. A gallon of unleaded gasoline cost an average $3.19 on Thursday, down from $5.02 in mid-June, according to AAA.

Yet Fed Chair Jerome Powell, who had been slow to recognize the inflation threat when it emerged in the spring of 2021, was in no mood to celebrate. Powell essentially shrugged off the signs of incremental progress.

Two good monthly reports are very welcome, he told reporters Wednesday. But we need to be honest with ourselves 12-month core inflation is 6% three times the Feds target. Its good to see progress but lets just understand we have a long ways to go to get back to price stability.

Powell seemed to bat down hopes that the Fed might end up cutting rates by late next year a move that typically acts like steroids for markets and the economy unless inflation had dropped significantly by then, which he does not appear to expect.

The policymakers increased their inflation forecast for next year above what they were expecting back in September. It suggested that they feel their anti-inflation fight isnt having as much impact as they had hoped.

Many economists were caught off-guard by that change. For next year, the Fed is projecting more rate hikes, a slower economy and higher unemployment than it did three months ago.

All those things typically help tame inflation. Yet the Feds officials predict that their preferred inflation gauge will be 3.1% at the end of 2023, up from their 2.8% forecast in September. Thats above their 2% target and likely too high for them to feel they can cut rates.

The Fed wasnt the only source of rising recession fears Thursday. The European Central Bank, which is waging its own aggressive war against inflation, signaled that it, too, might send rates higher than markets expected, thereby raising the likelihood of a downturn in Europe.

On Thursday, the U.S. government reported that Americans slashed their spending at retailers in November. That was disconcerting news in the midst of the holiday shopping season. And the Federal Reserve Banks of New York and Philadelphia issued downbeat reports on manufacturing in their regions. Yields on long-term Treasurys fell, a sign that bond investors are growing more concerned about a possible recession.

Even the goods news out Thursday  a drop in the number of Americans seeking unemployment benefits  had a downside: It reinforced the Feds concern that a strong and resilient job market is putting upward pressure on wages and overall inflation.

The Fed is especially worried that a worker shortage in the labor-intensive services sector everything from restaurants and hotels to airlines and entertainment venues could keep pay growth high and make inflation more intractable.

Sweet of Oxford Economics said he suspects that the Fed is overstating how strong inflation might be.

But he said he sympathized with its predicament: Powell and the other policymakers fear that a failure to curb high inflation even if it means a recession next year would lead to a central banks nightmare scenario: stagflation. Thats a worst-of-all-worlds combination of weak growth, high unemployment and persistent inflation.

Its a problem with no clear solution.

Faced with that choice, Sweet said, theyll do everything they can to prevent it.

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The 27 leaders also committed to move ahead with their own big stimulus plans for the sector. EU Commission President Ursula von der Leyen said that we also, on the European side, need to act to ensure that the European Union keeps its global leadership in the clean tech sectors.

The bloc argues the U.S. Inflation Reduction Act unfairly locks a longstanding friend out of the lucrative American market and excessively lavishes subsidies and brandishes a made-in-America approach that bodes ill for European multinationals.

I believe in healthy rules of the game when there is fair competition and everybody accepts the rules, French President Emmanuel Macron said. Its almost certain that IRA is not compatible with WTO and its rules, he said, referring to the World Trade Organization.

I want to defend jobs and industry in Europe, Macron said.

The French president said Americans have decided to heavily fund their clean tech industries in a bid to protect jobs and projects on American soil.

He cited the example of green hydrogen used to produce steel, arguing that this particular industry is four or five times more subsidized in the U.S. than in Europe. As a consequence, people only looking at market and subsidies would no longer set up projects in Europe, he said.

But with the longstanding allies facing Russia over the war in Ukraine and China as a systemic rival on the global stage, none of 27 EU leaders wanted to get too much in the face of President Joe Biden.

We are not going to open that debate with friends and allies in a period of war, said Macron.

Instead, the EU hopes that talks with the Biden administration can dull some of the sharpest edges of the IRA, part of which is set to kick in after New Years.

Biden has said there are glitches in the legislation, saying earlier this month alongside Macron that theres tweaks we can make to satisfy allies. Biden cited a provision that benefits anyone who has a free trade agreement with the U.S., including Canada and Mexico.

The EU and U.S. do not have a free trade agreement, and that is exactly what the EU thinks it should get.

We want to talk about the IRA with the United States, to get exemptions like Canada and Mexico, said the summits host, EU Council President Charles Michel.

The leaders were seeking to counter fears that the EU is a waning industrial power sticking to free and open trade ideals while others jump toward subsidies and protectionism to shield local industries during recession and tough economic times.

We are in Europe, really, at the point where we risk to be de-industrialized, Belgian Prime Minister Alexander De Croo said as he called for a common EU plan to keep homegrown companies in the vanguard of green technologies that should drive the EU to become climate neutral by 2050.

We must boost European public investment to accelerate the energy transition, von der Leyen wrote to the leaders. Without such an EU-wide plan, wed just be competing against one another, while the United States would be running away with everything, De Croo said.

The EUs struggles to come up with a strategic investment plan came into focus because of Bidens $369 billion investment plan.

EU leaders had long seen Bidens election new administration as a watershed moment after four years of Donald Trumps presidency during which trans-Atlantic relations steadily worsened.

Fears are that disagreements over IRA could lead to a trade war and weaken the united stance over the war in Ukraine.

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