The Federal Reserve hiked interest rates on Wednesday — a pivotal move that showed the central bank’s resolve to tackle inflation despite recent chaos in the US banking sector.
In a hotly anticipated decision, the rate-making Federal Open Market Committee hiked its benchmark rate by 0.25% — to a range of 4.75% to 5% — at the conclusion of the Fed’s closely watched policy meeting.
Fed Chair Jerome Powell told reporters that members of the FOMC “did consider” leaving interest rates unchanged due to concerns about the banking sector, but ultimately pushed ahead with a small hike as inflation runs high.
The chairman noted that the decision was “supported by a very strong consensus.” The bank crisis is likely to result in a tightening in credit conditions that could have the same cooling effect on the economy as an interest rate hike, Powell added.
“Such a tightening in financial conditions would work in the same direction as rate tightening,” Powell said. “You can think of it as being the equivalent of a rate hike or perhaps more than that.”
The Fed chair said a “small number of banks” had experienced “serious difficulties,” but he downplayed further risks for the sector. Overall, the banking system has “strong capital and liquidity” and “deposit flows have stabilized,” according to Powell.
Powell noted the rate-making Federal Open Market Committee’s statement now says “some additional policy firming may be appropriate” — a softer stance indicating that the Fed may not need to implement more interest rate hikes.
The tough call by the Fed had been the subject of fierce debate since Silicon Valley Bank and Signature Bank of New York collapsed in the largest US bank failures since the 2008 financial crisis.
Hedge fund boss Bill Ackman and tech billionaire Elon Musk were among those calling for the Fed to pause hikes — or even cut rates — to avoid more shocks to the economy. Others, such as ex-Treasury Secretary Larry Summers, urged the Fed to stay the course and lift rates higher despite the turmoil.
The increase marked the ninth consecutive interest rate hike for the Fed during a rapid tightening of monetary policy over the last year. The Fed also hiked by a quarter of a percentage point at its meeting in February.
Powell and his colleagues were forced to consider the US banking sector crisis even with inflation running at 6% — well above the Fed’s 2% target.
The Fed also released updated “dot plot” projections showing officials see benchmark interest rates topping out at 5.1% this year. Powell noted committee members currently do not expect to enact any rate cuts in 2023.
Economic growth is expected to be muted this year in the uncertain environment, with real GDP rising just 0.4%. Inflation is projected to sink to 3.3% by the end of the year.
“Investors’ wishes may come true: contagion risks are low enough for the Fed to hike rates and inflation pressures are soft enough for the Fed to be near the end of the rate hiking campaign,” LPL Financial chief economist Jeffrey Roach said.
US stocks initially rose after Powell’s press conference but then tumbled. The Dow Jones Industrial Average was up as much as 200 points before plunging 530 points, or 1.6%. The tech-heavy Nasdaq and the broad-based S&P 500 were also down 1.6%.
Another interest rate hike in March was considered a foregone conclusion earlier this month after a series of hotter-than-expected economic reports.
Just days before the bank failures, Powell had warned the Fed would need to raise rates higher than previously expected to bring down prices.
While interest rate hikes are the Fed’s key inflation-fighting tool, they also increase pressure on businesses by making interest payments and forms of borrowing more expensive.
A rapid surge of interest rate hikes over the last year was a key factor in SVB’s collapse, as the tech sector’s one-time favorite lender was forced to eat a $1.8 billion loss on a fire sale of its bond holdings. A recent study found nearly 200 other banks face similar risks.
Powell said Fed officials are working to assess what went wrong at SVB and what guardrails should be implemented to prevent similar collapses in the future.
“Silicon Valley Bank management failed badly,” Powell said. “They grew the bank very quickly, they exposed the bank to significant liquidity risk and interest rate risk.”
Bank stocks remained under pressure this week due to trouble at regional lender First Republic, which faced a bank run from worried depositors.
Elsewhere, UBS Group stepped in with an emergency takeover of Swiss banking giant Credit Suisse after questions emerged about its survival.
The Fed’s announcement was in line with expectations.
Ahead of the FOMC’s announcement, the market was pricing in an 86.4% probability of a quarter-point rate hike and just a 13.6% chance that the Fed would leave rates unchanged, according to CME Group’s FedWatch tool.