Fed, Focusing on Inflation, Hikes Interest Rate Again Despite Banking Turmoil

The central bank raised its interest rate to its highest level since 2006

Federal Reserve Chair Jerome Powell testifies before the Senate Banking Committee March 7, 2023 in Washington, DC. Powell spoke on the state of the U.S. economy and suggested that interest rates will need to stay higher for longer than expected in order to curb inflation.

Win McNamee / Getty Images

The financial fallout from the collapse of Silicon Valley Bank wasn’t enough to interrupt the Fed’s campaign of anti-inflation interest rate hikes. 

The Federal Reserve raised its benchmark interest rate 25 basis points Wednesday, to a range of 4.75% to 5%, its highest since 2006. In deciding to raise rates for its ninth meeting in a row, the central bank prioritized subduing inflation over minimizing the strain high interest rates are putting on the banking system in the midst of a smoldering crisis.

“The U.S. banking system is sound and resilient," the central bank's policy-setting committee said in a statement. "The Committee remains highly attentive to inflation risks."

Even as they raised rates, Fed officials signaled they might be done with the campaign, or close to it. FOMC members projected that the benchmark rate would peak after just one more hike, and did not repeat language from the previous statement in February about the need for “ongoing increases” to the interest rate target.

Instead the Fed said “some additional policy firming” could be needed depending on data—signals that markets took as dovish. 

Stocks rose in the immediate aftermath of the policy announcement and then wavered up and down before Fed chair Jerome Powell’s press conference, suggesting the move sent mixed messages to traders, said Giles Coughlan, chief market analyst at HYCM.

“There's something for the doves, there's something for the hawks, and they've sort of equalized each other out,” he said.

The Fed’s move will raise interest rates for consumer borrowing costs including credit cards and car loans, and, indirectly, puts upward pressure on mortgage rates. By making it harder for individuals and businesses to borrow money, Fed officials hope to reduce demand for goods and services and allow supply and demand to rebalance and drive consumer price increases—running at 5.4% a year as of January by the Fed’s preferred measure—down to the central bank’s 2% goal. 

The rate hikes risk slowing down the economy so much that a recession ensues, a possibility that economists say has only grown more likely amid the banking turmoil. While the Fed has signaled its determination to raise rates aggressively to control inflation that has proved more stubborn than previously expected, the latest hike wasn’t a foregone conclusion, and was half the size that markets had anticipated before the banking turmoil erupted. Some economists, including those at Goldman Sachs, had predicted the Fed would pause its rate hikes in the face of the banking crisis that started earlier in March with the failure of Silicon Valley Bank. 

Fed officials acknowledged that bankers could be more cautious about lending in the wake of the crisis, and do some of the Fed's anti-inflation work for it.

"Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation," The Fed said in a statement.

“If the lifeblood of the economy is cut, which is credit, and that becomes harder to come by, that is disinflationary,” Coghlan said.

The latest hike, however, signals confidence among Fed officials that collapse of SVB and Signature banks, and woes at other institutions including First Republic and Credit Suisse, are not ballooning into a full-blown financial crisis. Regulators including the Fed, the Treasury Department, and the Federal Deposit Insurance Corporation have all taken drastic actions in recent days to shore up the banking system including making uninsured SVB and Signature depositors whole and assuring they’d do the same for customers at smaller banks if they also failed. 

“The banking system is sound and it's resilient,” Powell said at a press conference. “We took powerful actions with Treasury in the FDIC, which demonstrate that all depositors’ savings are safe and the banking system is safe.”

The move was in line with the Fed’s European Union counterpart. Authorities at the European Central Bank raised key interest rates 50 basis points last week, saying their own banking system was “resilient.” 

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