WASHINGTON — The Federal Reserve extended its year-long fight against high inflation Wednesday by raising its key interest rate a quarter-point despite concerns that higher borrowing rates could worsen the turmoil that has gripped the banking system.
“The U.S. banking system is sound and resilient,” the Fed said in a written statement released after its two-day meeting.
At the same time, the Fed warned that the financial upheaval stemming from the collapse of two major banks is “likely to result in tighter credit conditions” and “weigh on economic activity, hiring and inflation.”
The central bank also signaled that it's likely nearing the end of its aggressive series of rate hikes. In a statement it issued, it removed language that had previously indicated that it would keep raising rates at upcoming meetings. The statement now says “some additional policy firming may be appropriate” — a weaker commitment to future hikes.
And in a series of quarterly economic projections, Fed officials forecast that they expect to raise their key rate just one more time – from its new level Wednesday of about 4.9% to 5.1%. That is the same peak level they had projected in December.
The latest rate hike suggests that Chair Jerome Powell is confident that the Fed can manage a dual challenge: Cool still-high inflation through higher loan rates while defusing the financial upheaval in the banking sector through emergency lending programs and the Biden administration’s decision to cover uninsured deposits at two failed U.S. banks.
The Fed's decision to signal that the end of its rate-hike campaign is in sight may also soothe financial markets as they continue to digest the consequences of U.S. banking turmoil and the takeover last weekend of Swiss bank Credit Suisse by its larger rival.
The Fed’s benchmark short-term rate has now reached its highest level in 16 years. 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 have also heightened the risk of a recession.
The Fed’s latest decision, after a two-day policy meeting, reflects an abrupt shift. Early this month, Powell had told a Senate panel that the Fed was considering raising its rate by a substantial half-point. At the time, hiring and consumer spending had strengthened more than expected, and inflation data had been revised higher.
In its statement, the Fed included some language that indicated that its fight against inflation is still far from complete. It said that hiring is “running at a robust pace” and noted that “inflation remains elevated.” It removed the phrase, “inflation has eased somewhat,” which it had included in its statement in February.
The troubles that suddenly erupted in the banking sector two weeks ago likely led to the Fed’s decision Wednesday to impose a smaller rate hike. Some economists have cautioned that even a modest quarter-point rise in the Fed’s key rate, on top of its previous hikes, could imperil weaker banks whose nervous customers may decide to withdraw significant deposits.
Silicon Valley Bank and Signature Bank were both brought down, indirectly, by higher rates, which pummeled the value of the Treasurys and other bonds they owned. As anxious depositors withdrew their money en masse, the banks had to sell the bonds at a loss to pay the depositors. They were unable to raise enough cash to do so.
After the fall of the two banks, the Swiss bank Credit Suisse was taken over by its larger rival UBS last weekend. Another struggling bank, First Republic, has received large deposits from its rivals in a show of support, though its share price plunged Monday before stabilizing.
THIS IS A BREAKING NEWS UPDATE. AP’s earlier story follows below.
The Federal Reserve is grappling with a hazier economic picture, clouded by turmoil in the banking industry and still-high inflation, just as it meets to decide whether to keep raising interest rates or declare a pause.
Most Fed watchers expect the central bank to announce on Wednesday afternoon a relatively modest quarter-point hike in its benchmark rate, its ninth increase since March of last year. Yet for the first time in recent memory, there remains some uncertainty about what the Fed will announce when it issues its policy statement at 2 p.m. Eastern time.
The central bank will not only have to decide whether to extend its year-long streak of rate hikes despite the jitters roiling the financial industry. The Fed’s policymakers will also try to peer into the future and forecast the likely path of growth, employment, inflation and their own interest rates.
Those forecasts will be particularly difficult this time. In their most recent forecasts in December, Fed officials projected that they would raise their short-term rate to about 5.1% by the end of this year, roughly a half-point above the current level. Some Fed watchers expect the policymakers on Wednesday to raise that forecast to 5.3%.
But the upheaval in the banking industry has made any expectations far less certain. The Fed is meeting less than two weeks after Silicon Valley Bank failed in the second-largest bank collapse in American history. That shock was followed by the failure of another major bank, Signature Bank. A third, First Republic Bank, was saved from collapse by a $30 billion cash infusion.
Given the heightened uncertainties overhanging the financial system, there's a small chance that the Fed could decide not to issue its usual quarterly projections. Three years ago, when the pandemic struck, the Fed moved up a scheduled policy meeting to a Sunday, rather than on Tuesday and Wednesday, to urgently address the economic anxieties caused by new pandemic restrictions. After that meeting, the Fed didn’t release any quarterly projections.
At the time, Powell said that issuing economic and interest rate forecasts, when the consequences of the COVID-19 pandemic were so unclear, “could have been more of an obstacle to clear communication than a help.” Still, the unusual decision then was as much a reflection of the chaos of the early pandemic as it was of the uncertain outlook.
If the Fed does raise its key rate by a quarter-point on Wednesday, it would reach roughly 4.9%, the highest point in nearly 16 years. Early this month, Powell had said in congressional testimony that a half-point rate increase would be possible at this week's meeting. The banking crisis has suddenly upended that outlook.
It will be a tough call for the 11 Fed officials who will vote on the rate decision. With hiring still strong, consumers still spending and inflation still elevated, a rate hike would normally be a straightforward move.
Not this time. The Fed is expected to treat inflation and financial turmoil as two separate problems, to be managed simultaneously by separate tools: Higher rates to address inflation and greater Fed lending to banks to calm financial turmoil.
Complicating matters will be the difficulty in determining the impact on the economy of the collapse of Silicon Valley and Signature. The Fed, Federal Deposit Insurance Corp., and Treasury Department agreed to insure all the deposits at those banks, including those above the $250,000 cap. The Fed also created a new lending program to ensure that banks can access cash to repay depositors, if needed.
But economists warn that many mid-sized and small banks, in order to conserve capital, will likely become more cautious in their lending. A tightening of bank credit could, in turn, reduce business spending on new software, equipment and buildings. It could also make it harder for consumers to obtain auto or other loans.
Some economists worry that such a slowdown in lending could be enough to tip the economy into recession. Wall Street traders are betting that a weaker economy will force the Fed to start cutting rates this summer. Futures markets have priced in three quarter-point cuts by the end of the year.
The Fed would likely welcome slower growth, which would help cool inflation. But few economists are sure what the effects would be of a pullback in bank lending.
Other major central banks are also seeking to tame high inflation without worsening the financial instability caused by the two U.S. bank collapses and a hasty sale of the troubled Swiss bank Credit Suisse to its rival UBS.
Even with the anxieties surrounding the global banking system, the Bank of England faces pressure to approve an 11th straight rate hike Thursday with annual inflation having reached 10.4%.
And the European Central Bank, saying Europe’s banking sector was resilient, last week raised its benchmark rate by a half point to combat inflation of 8.5%. At the same time, the ECB president, Christine Lagarde, has shifted to an open-ended stance regarding further increases. In light of uncertainties, she said, “we are neither committed to raise further nor are we finished with hiking rates.”
In the United States, most recent data still points to a solid economy and rampant hiring. Employers added a robust 311,000 jobs in February, the government said earlier this month. And while the unemployment rate rose, from 3.4% to a still-low 3.6%, that mostly reflected an influx of new job-seekers who were not immediately hired.
Consumer spending was robust in January, fueled in part by a large cost-of-living adjustment for 70 million recipients of Social Security and other benefits. The Federal Reserve Bank of Atlanta projects that the economy will have expanded at a healthy annual rate of 3.2% in the first three months of this year.