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The Federal Reserve on Wednesday raised interest rates again and signaled at least one more hike this year, but the failure of Silicon Valley Bank also forced the central bank to adopt a more cautious strategy despite stubbornly high inflation.
The Fed lifted its benchmark federal funds rate by a quarter of a percentage point to a nearly 16-year high of 4.75% to 5%. A year ago, that rate was close to zero.
Fed Chairman Jerome Powell said in a press conference the central bank was planning to “continue with ongoing rate hikes” before the failure of Silicon Valley Bank.
The bank’s collapse and ensuing stress in the financial system forced the Fed to consider a pause in interest-rate increases, Powell admitted.
See: Silicon Valley Bank branches closed by regulator in biggest bank failure since Washington Mutual
Also: House Democrats demand investigation into Goldman Sachs’s relationship with Silicon Valley Bank
The market volatility spread quickly across the globe and eventually led to the merger over the weekend of Swiss banking giant Credit Suisse CH:CSGN CS by rival Swiss investment bank UBS UBS CH:UBSG.
Yet stubbornly high inflation and a strengthening labor market in early in 2023 ultimately persuaded Fed officials they needed to raise rates gain, Powell said. The tight labor market is pushing up wages and adding to high inflation.
The turbulence in the U.S. financial system has also died down after the Fed acted swiftly to safeguard banks with a new emergency loan program. Banks can quickly get cash if depositors decide to move their money. It was a run by depositors that caused the trouble at Silicon Valley Bank.
“The Fed decided that it could indeed walk and chew gum at the same time, pressing on with a quarter point rate hike to quell inflation, and clearly relying on its lending facilities to address concerns over financial system stability,” said chief economist Avery Shenfeld of CIBC World Markets.
Even though he repeatedly stressed the banking system is “sound,” Powell also said there’s likely to be some residual damage to the economy. The extent remains to be determined, however.
Economists say banks could tighten lending standards and trigger a so-called credit crunch in which loans are harder for businesses and consumers to obtain. Lending is the lifeblood of the U.S. economy.
Still, the Fed left itself some wiggle room to raise interest rates as needed to tame high inflation. “Some additional policy firming may be appropriate,” the statement said.
One reason the Fed might need to do more is that inflation is not falling as quickly as hoped.
The central bank’s latest forecast signals the PCE index, the Fed’s preferred price barometer, will ease to 3.3% by year end. But that’s up from the Fed’s prior 3.1% estimate.
See: CPI shows little progress on cooling off high U.S. inflation
Also: CPI data ‘not good enough to stop the Fed’ from raising rates next week
The index rose at 5.4% yearly pace as of January, the most recent data available.
Powell insisted the Fed will restore inflation to its 2% target.
“We will get inflation down in time,” he said. “No one should doubt that.”
Inside the Fed, members were divided over how to proceed.
Seven of 18 Fed officials penciled in two rate hikes to come by year-end. Ten saw just one more rate hike this year, however.
As a result, the central bank’s updated “dot plot” forecast now shows the Fed raising rates just one more time this year to a range of 5%-to-5.25% range.
The Fed is not projecting any rate cuts this year.
Markets are skeptical. Participants still see the central bank lowering interest rates this year. That is a clear sign investors are worries about a sharp downturn, economist said.
See also: The Fed’s updated economic forecast also showed slightly weaker growth this year.
The FOMC vote to raise the policy interest rate was unanimous. Fed policy makers will meet again in early May.
