The Fed, still focused on inflation, hiked rates amid banking uncertainty

WASHINGTON — Federal Reserve officials raised interest rates a quarter point on Wednesday in an effort to balance two conflicting issues: the risk that inflation would remain high and the threat that turmoil in the banking system would dramatically slow the economy.

The Fed on Wednesday, interest rates pushed to a range of 4.75 percent to 5 percent, and officials predicted another rate hike in 2023 — though they hinted that even that was uncertain. In doing so, policymakers tried to indicate that they remained focused on warding off price increases, but also paid attention to financial threats.

“In assessing the need for further hikes, we will focus on incoming data and the evolving outlook, and in particular our assessment of the actual and expected effects of credit tightening,” said Jerome H. Powell, the Fed Chairman , ahead of his post-meeting press conference.

The Fed’s statement said that some additional rate moves “may” be warranted, and Mr. Powell stressed that “possibly” was crucial: officials don’t know that yet.

His remarks underlined that the prospects of whether interest rates would rise further – and if so, by how much – had become uncertain due to unrest in the banking sector, which would make it harder to get loans, slowing the economy.

Officials predict that next year they will cut rates more slowly than they expected, leaving rates stuck at 4.3 percent by the end of 2024, down from 4.1 percent. That suggested that the fight for stable inflation could be longer and more gradual than many expected even a few months ago, although the outlook is complicated by banking turmoil.

The forecasts and comments of Mr. Powell both underlined that his central bank is facing a complicated moment – ​​and is trying to buy itself time to decide how to respond.

The Fed has raised interest rates at its fastest pace since the 1980s over the past year to try to cool down the hot economy. Yet there has been inflation surprisingly stubbornand the labor market remains strong. Those facts would likely have called for a more aggressive response from the Fed.

But high-profile bank The collapses of recent weeks have underlined the risk that rapid interest rate moves by the Fed could fuel financial instability. Silicon Valley Bank, which filed for bankruptcy on March 10, did so in part because it had incurred large losses on its securities portfolio as interest rates rose. And more importantly, the banking problems threaten to weigh on lending and spending, increasing the risk of a recession.

“The bottom line is, credit conditions are going to get tighter, and the Fed is recognizing that,” said Diane Swonk, chief economist at KPMG. The Fed “would like a slow cooldown,” she added. “They just don’t want a freezer. And that increases the chance that the economy will fall through the ice.”

Shares, which initially rose after the Fed’s decision was announced, fell sharply on Wednesday, finishing the day down 1.65 percent after investors processed the Fed’s interest rate change and comments from Treasury Secretary Janet Yellen suggesting that the government was not looking for a plan to expand broad protection for uninsured deposits.

The ongoing jitters about the banking system come at a time when the economy seemed otherwise strong – despite the Fed’s policy adjustments.

The Fed quickly raised its policy rate since March 2022, making it more expensive to borrow money in the hopes of cooling spending and ultimately curbing inflation. Officials enacted four consecutive rate hikes of three-quarters of a point last year before slowing to half a point in December and a quarter point beginning of February.

Just two weeks ago, many economists and investors thought central bankers might speed up their rate hikes at this meeting because incoming economic data had maintained so much momentum. Policymakers had hinted that they might revise their forecasts for the rate hike rate in 2023.

“As of a few weeks ago, it looked like we’d have to raise rates — over the course of the year — more than we anticipated,” acknowledged Mr. Powell Wednesday.

But the Fed chairman explained that the banking problems had changed the outlook. By making it more difficult for consumers to access credit to buy homes or cars or make other large purchases, the problems could weigh on demand, allowing the Fed to adjust interest rates less drastically.

“Recent developments are likely to lead to tighter credit conditions for households and businesses and weigh on economic activity, hiring and inflation,” the Fed’s policy committee said in its post-meeting statement. “The magnitude of these effects is uncertain.”

Economists at Goldman Sachs estimate that the effect could be equivalent to the slowdown from one or two rate hikes by the Fed. Mr. Powell, at his press conference, seemed to suggest that his assessment – ​​though far from clear – was in that ballpark.

“You can think of it as the equivalent of a rate hike, or maybe more than that,” he said. “It’s obviously not possible to make that estimate with any precision today.”

But even with a bank-induced blow to the economy, the process of restoring stable inflation could take some time.

Based on their new economic estimates, policymakers expected rapid price increases to be a lasting problem. Officials thought inflation would finish at 3.3 percent in 2023, up from the 3.1 percent in their December projections. That measure of inflation was 5.4 percent in January.

Central bankers aim for an average inflation rate of 2 percent over time. While price increases have slowed from last year’s very high levels — the Fed’s target inflation index peaked at about 7 percent last summer — that progress hasn’t been as stable as many had hoped.

Continued price increases weigh on household budgets and there is a risk that a prolonged period of rapid inflation could make price increases a more permanent feature of the US economy.

That’s what central bankers are trying to avoid. By raising interest rates rapidly over the past year, they hoped to cool growth and bring inflation under control quickly. While rapid monetary policy adjustments increase the risk of financial turmoil and other problems, central bankers fear it will be harder and more painful to eradicate inflation if it becomes entrenched in the everyday behavior of households and businesses.

Once people get used to asking for large wage increases to cover rising costs, and companies get used to making regular price increases, it may take a larger economic downturn to reverse those habits and change the course of price increases.

“We need to bring inflation down to 2 percent,” said Mr. Powell. “The cost of failure is much higher.”

A crucial question is whether the Fed will be able to slow the economy enough to cool inflation without a recession. Mr Powell suggested he still thought such a “soft landing” was possible – although he acknowledged that the recent banking turmoil has not helped.

“I think that path still exists,” Mr. Powell said. “We’re definitely trying to find it.”

Wall Street analysts have pointed out that risks are greater in a world of financial turmoil, as problems in the banking sector can easily spill over to Main Street.

“You have the trigger that can make it into a deeper recession — can make it a hard landing,” said Priya Misra, the head of global interest rate strategy at TD Securities.