The U.S. Federal Reserve pressed ahead with its ninth consecutive interest rate hike, but signalled that it may be near the end of its monetary policy tightening campaign as it grapples with the most serious banking crisis since 2008.
Fed officials voted unanimously on Wednesday to raise the benchmark lending rate by a quarter-point to a range of 4.75 per cent to 5 per cent. At the same time, they dialled back their language around future interest rate hikes, noting that financial sector turmoil could spill out into the broader economy.
“Events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes,” Chair Jerome Powell said in a news conference after the rate announcement.
“As a result, we no longer state that we anticipate that ongoing rate increases will be appropriate to quell inflation. Instead, we now anticipate that some additional policy firming may be appropriate,” he said.
The collapse of three U.S. regional banks, and the emergency takeover of Swiss lending giant Credit Suisse CS-N, has dramatically altered the landscape for the Fed and other central banks around the world. Inflation remains high. But central bankers are now having to balance their role as inflation-fighters against their role as lenders-of-last-resort to a jittery banking sector that has been pummelled by rapidly rising interest rates.
The annual rate of consumer price inflation in the United States was 6 per cent in February, still three times the Fed’s target.
Bank of Canada officials worried inflation could get stuck above 2 per cent, minutes show
Mr. Powell urged calm on Wednesday, arguing that the U.S. banking system remains fundamentally sound. At the same time, he said that the Fed and other branches of the U.S. government are prepared to act to forestall further bank runs and prevent contagion spreading through the financial system.
“We have the tools to protect depositors when there’s a threat of serious harm to the economy or to the financial system, and we’re prepared to use those tools. And I think depositors should assume that their deposits are safe,” Mr. Powell said.
After the failure of Silicon Valley Bank on March 10, the Fed announced a US$25-billion lending facility, allowing regional small U.S. banks to swap their illiquid assets for cash in the event of a bank run. It also pumped liquidity into the financial system through its discount window, loaning banks US$154-billion last week, up from US$5-billion the preceding week and above levels seen in 2008.
Meanwhile, the U.S. Treasury and Federal Deposit Insurance Corporation guaranteed the deposits of Silicon Valley Bank and Signature Bank, including those higher than the normal US$250,000 insurance threshold. U.S. Treasury Secretary Janet Yellen said on Tuesday that she was willing to extend this guarantee to other banks if necessary.
Alongside Wednesday’s rate decision, members of the rate-setting Federal Open Markets Committee published their latest projections for the economy and the trajectory of interest rates. Despite weakening their commitment to tighten monetary policy, FOMC members still see the federal funds rate rising again to the range of 5 per cent to 5.25 per cent, and don’t expect rate cuts until 2024. That’s little changed from their “dot-plot” projections in December.
The bigger shift came in Mr. Powell’s own comments on rate hikes. Several days before the collapse of Silicon Valley Bank, he told a congressional hearing that he expected to keep raising rates aggressively, floating the possibility of a half-point rate hike on March 22.
By the time the FOMC met this week, officials were openly debating whether to raise rates at all, Mr. Powell said Wednesday.
The key question for monetary policy makers is how much disturbances in the banking sector will feed into the real economy. Financial upheaval tends to lead to a pullback in lending and a drop in consumer and business confidence. This could help the Fed in its attempt to slow the economy and control inflation. But its tough to judge the impact in real time.
“It’s possible that the effects of recent turmoil could turn out to be quite modest or drive material further tightening of financial conditions. We simply don’t know,” Mr. Powell said.
A team of economists at Moody’s offered a downbeat analysis of the situation shortly after the Fed’s rate announcement.
“Even before bank stress became evident, we had expected global credit conditions to continue to weaken in 2023 as a result of significantly higher interest rates and lower growth, including recessions in some countries,” the Moody’s economists wrote in a note to clients.
“Looking ahead, the longer that financial conditions remain tight, the greater the risk that stresses spread beyond the banking sector, unleashing greater financial and economic damage than we anticipated in our baseline.”
Markets sold off after the rate announcement and Mr. Powell’s press conference. The S&P 500 finished down 1.65 per cent while the Nasdaq Composite fell 1.6 per cent. Shares of First Republic Bank, which received an emergency infusion of US$30-billion from 11 other U.S. banks last week, dropped 15.5 per cent.
Interest rate swaps, which capture market beliefs about future monetary policy decisions, are pricing in rate cuts starting as early as July. When asked about this pricing, Mr. Powell responded that “rate cuts are not in our base case.”
Canadian Imperial Bank of Commerce chief economist Avery Shenfeld said in a note to clients that he expects one more rate hike from the Fed in May, and no rate cuts until next year. But he said that the more aggressive market pricing for cuts isn’t entirely unreasonable “on the grounds that the Fed’s hiking forecasts have, at the end of a tightening cycle, often showed further increases that didn’t in fact happen.”
“Typically, the Fed starts to show some softening of those further hikes, as they have today, before then flipping into a pause or even some cuts,” Mr. Shenfeld wrote.
The Bank of Canada, in contrast to the Fed, has already moved to the sidelines on rate hikes. After raising rates eight consecutive times, Canada’s central bank held its benchmark rate steady at 4.5 per cent earlier this month, making it the first major central bank to pause its monetary policy tightening campaign.
A summary of deliberations that informed the bank’s March 8 rate decision, published Wednesday, showed that policy makers remained nervous about inflation getting “stuck materially above the 2 per cent target.” But these concerns were not enough to keep them from halting rate hikes. And the subsequent banking-sector upheaval, which began days after the rate announcement, may reaffirm the bank’s decision to hit pause.