The Federal Reserve today hiked interest rates by 25 basis points, slashing its planned raise after banking collapses caused turmoil in the sector.
The central bank wrapped its two-day meeting to announce a new target range of 4.75 to 5 percent, pushing the rate a quarter percentage point higher, in the ninth successive increase since last year to combat rampant inflation.
But the Fed hinted in its new policy statement that the historic inflation-busting drive may be reaching its conclusion. ‘The committee anticipates that some additional policy firming may be appropriate,’ the statement said.
The Fed dropped a phrase used in its previous eight statements that the committee believed ‘ongoing increases’ would be appropriate. Wall Street reacted favorably to the news with the Dow Jones up 46 points and the S&P 500 gaining 0.37 percent.
While this is the highest rate since September 2007, the Fed was forecast to make a 50 basis point hike just two weeks ago before the collapse of Silicon Valley Bank. Jerome Powell admitted the Fed had ‘considered’ pausing the rate hike altogether as a result of the crisis in the banking sector.
Jerome Powell, chairman of the US Federal Reserve, arrives before a Senate Banking, Housing, and Urban Affairs Committee hearing in Washington, DC, US, on Tuesday
Inflation has cooled dramatically from a high of 9.1 per cent in June, to six per cent in February. That’s still far above the 2.5 rate desired by federal officials – but it suggests interest rate hikes are working
However, the Fed Chair cited data on inflation and jobs that ‘came in stronger than expected’ meaning that they could push ahead with the rise.
The meltdown of SVB, the biggest banking failure since the Great Recession, sparked wider chaos in the sector which 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 stepping on the brake to prevent further upheaval in the commercial banking sector.
The central bank may have gained some wiggle room for another rate hike as stock markets and banking shares have rallied this week after global financial authorities took measures to prevent contagion.
Despite making eight consecutive hikes since it began monetary tightening last year, prices have remained stuck well above the Fed’s long-term inflation target of two percent.
The implosions of SVB and two other regional lenders pummeled banking stocks around the world last week, with Credit Suisse swallowed up 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 start of the year and the uncertainty in the banking sector has led most analysts to predict the Fed will continue with a more modest hiking cycle than was previously predicted.
‘After the recent news, the recent developments in the financial markets, we now see a kind of risk to both sides,’ said Stephen Juneau, senior US economist at Bank of America Global Research.
‘We’re still looking for a 25 basis point hike in March, May, and June,’ he said.
Treasury Secretary Janet Yellen said Tuesday that the US banking sector was ‘stabilizing’ after authorities stepped in to protect deposits following the failures of SVB and Signature Bank.
But she conceded that ‘similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion.’
Yellen’s comments contributed to this week’s relief rally in the stock markets, along with actions by the Fed and other major central banks to improve lenders’ access to liquidity.
This graphic shows the Federal Interest Rate up to January 2023, with the latest rate announced by the Fed on Wednesday morning
The challenge on Wednesday for Fed Chair Powell will be to convey the message that the banking system has turned a corner while continuing to confront inflation.
‘The Fed will need to emphasize that it has a dual mandate of full employment and stable prices, with the latter nowhere close to being met,’ Oxford Economics’ chief US economist Ryan Sweet wrote in a note to clients.
It is likely to be ‘a bit more dovish’ in the language that accompanies the decision, Juneau from Bank of America said, adding he expects the US central bank to reinforce its confidence in the banking system in the statement.
The Fed will also update its GDP growth and interest-rate projections on Wednesday.
Its announcement will follow on the heels of the European Central Bank’s decision last week to raise its rates by a hefty 0.5 percentage points.
ECB chief Christine Lagarde warned on Wednesday that the eurozone’s monetary policymakers ‘will still have ground to cover to make sure that inflation pressures are stamped out.’
She said the recent banking turmoil could add to ‘downside risks’ in the single currency area.