The Federal Reserve today raised interest rates by 25 basis points, cutting its planned increase after bank collapses caused turbulence in the sector.
The central bank wrapped up its two-day meeting to announce a new target range of 4.75 to 5 percent, raising the rate by a quarter of a percentage point, for the ninth straight increase since last year to combat runaway inflation.
While this is the highest rate since 2007, the Federal Reserve was anticipated to make a 50 basis point hike just two weeks before Silicon Valley Bank’s collapse.
The collapse of the $200 billion firm, the biggest banking failure since the Great Recession, sparked broader chaos in the sector that has now seen the demise of New York-based lender Signature and global investment beast Credit Suisse. .
The Fed is walking a tightrope between continuing to raise rates to combat high inflation or hitting the brakes to prevent further turmoil in the commercial banking sector.
Jerome Powell, Chairman of the US Federal Reserve, arrives before a Senate Banking, Housing and Urban Affairs Committee hearing Tuesday in Washington, DC, US.
Inflation has cooled sharply from a high of 9.1 percent in June to 6 percent in February. That is still well above the 2.5 rate desired by federal officials, but it suggests that the interest rate hikes are working.
Fed Chairman Jerome Powell will speak at 2:30 pm, when investors will listen closely for any indication that the Fed is abandoning its previous strong position that ‘continued hikes’ are ‘appropriate’.
Officials will also release their projections for unemployment, inflation and gross domestic product. The forecasts come as the presidential campaign is in full swing, with the battered economy hurting Joe Biden’s approval rating.
The Fed may have gained some leeway for another rate hike, as stock markets and bank shares have rallied this week after global financial authorities took action to stave off contagion.
Despite making eight straight hikes since monetary tightening began last year, prices have remained well above the Fed’s long-term inflation target of 2 percent.
Implosions by SVB and two other regional lenders hit bank shares around the world last week, with Credit Suisse being taken over by Swiss rival UBS after its shares sank to a record low.
Asian stock markets and most European indices rose ahead of the Fed’s decision on Wednesday.
The combination of hot economic data at the beginning of the year and uncertainty in the banking sector has led most analysts to predict that the Fed will continue with a more modest hike cycle than previously anticipated.
“After the recent news, the recent developments in the financial markets, we now see kind of a risk on both sides,” said Stephen Juneau, a senior US economist at Bank of America Global Research.
“We are still looking for a 25 basis point increase in March, May and June,” he said.
Treasury Secretary Janet Yellen said on Tuesday the US banking sector was “stabilizing” after authorities stepped in to protect deposits following the failures of SVB and Signature Bank.
But he conceded that “similar actions could be justified if smaller institutions suffer runs on deposits that present a risk of contagion.”
Yellen’s comments contributed to this week’s relief rally in stock markets, along with actions by the Fed and other major central banks to improve lenders’ access to liquidity.
This chart shows the federal interest rate through January 2023, with the latest rate announced by the Fed on Wednesday morning.
Wednesday’s challenge for Fed Chairman Powell will be to get the message across that the banking system has turned around as it continues to deal with inflation.
“The Fed will need to emphasize that it has a dual mandate of full employment and stable prices, and the latter is nowhere near being fulfilled,” Oxford Economics chief US economist Ryan Sweet wrote in a note to clients.
He is likely to be “a bit more dovish” on the language accompanying the decision, Bank of America’s Juneau said, adding that he expects the US central bank to bolster its confidence in the banking system in the statement.
The Fed will also update its projections for GDP growth and interest rates on Wednesday.
His announcement will follow in the footsteps of the European Central Bank’s decision last week to raise its rates by 0.5 percentage points.
ECB chief Christine Lagarde warned on Wednesday that eurozone policymakers “will still have some ground to cover to ensure that inflationary pressures are removed.”
He said the recent banking turmoil could add to “downside risks” in the single currency area.