The Federal Reserve has been engaged in a year-long fight against high inflation, and yesterday, it extended its efforts by raising its key interest rate by a quarter-point. Despite concerns that higher borrowing rates could worsen the turmoil that has gripped the banking system, the Federal Reserve remains confident in the soundness and resilience of the U.S. banking system.
In a statement following its latest policy meeting, the central bank noted that the fall of two major banks is “likely to result in tighter credit conditions” and “weigh on economic activity, hiring, and inflation.” The Federal Reserve acknowledged that its inflation fight remains far from complete and removed the phrase “inflation has eased somewhat” from its February statement.
The policymakers forecast that they expect to raise their key rate just once more. Still, the central bank signaled that it’s likely nearing the end of its aggressive streak of rate hikes by removing language that had previously said it would keep raising rates at future meetings. The statement now says, “some additional policy firming may be appropriate,” indicating a weaker commitment to future hikes.
Speaking at a news conference, Chair Jerome Powell acknowledged that some banks may reduce their pace of lending at a time of high anxiety in the financial system. Any such pullback in lending, he said, could slow the economy and possibly act as the equivalent of an additional quarter-point rate hike. “Events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses,” the Fed chair said. “It is too soon to determine the extent of these effects and therefore too soon” for the Fed to know how or whether its plans for interest rates might be affected.
Despite the Fed’s projection that it may impose only one more rate hike, Powell said the central bank may still choose to carry out additional hikes if inflation remained chronically high. The process of getting inflation back down to 2 percent, he noted, has a long way to go and is likely to be bumpy. In a response to a question about rate cuts this year, Powell said “just don’t see cuts this year” and added “rate cuts are not in our base case”. Markets are still pricing 3 rate cuts in 2023.
Yesterday’s rate hike, the Fed’s ninth since last March, suggests that Powell is confident that the Fed can manage a dual challenge: Cool still-high inflation through higher loan rates while defusing turmoil in the banking sector through emergency lending programs and the Biden administration’s decision to cover uninsured deposits at the two failed banks.
Powell acknowledged that “we do need to strengthen supervision and regulation” and declared the overall banking system secure, saying, “These are not weaknesses that are there at all broadly through the system.”
The Fed’s benchmark short-term rate has reached its highest level in 16 years, and the new level will likely lead to higher costs for many loans, from mortgages and auto purchases to credit cards and corporate borrowing. The succession of Fed rate hikes has also heightened the risk of a recession.
The troubles that suddenly erupted in the banking sector two weeks ago likely led to the Fed’s decision to raise its benchmark rate by a quarter-point rather than a half-point. Some economists have cautioned that even a modest quarter-point rise in the key rate, on top of its previous hikes, could imperil weaker banks whose nervous customers may decide to withdraw significant deposits.
