Following a two-day meeting of its monetary policy committee in Washington, the central bank announced Wednesday that it would raise its interest rate target by a quarter of a percentage point. The move comes after the Fed conducted another February hike of the same magnitude and a barrage of enormous half-point and 0.75-point increases before that.
The central bank’s key overnight rate is now 4.75% to 5%. Rates are now the highest they have been since 2007, at the outset of the global financial crisis.
The move, while expected, is a controversial one due to the volatility in the financial sector following SVB’s failure nearly two weeks ago. The rate hike sends a sign that the Fed continues to see inflation as a bigger threat than the economic repercussions of the uncertainty about the banking system.
“In the past two weeks, serious difficulties at a small number of banks have emerged. History has shown that isolated banking problems if left unaddressed can undermine confidence in healthy banks and threaten the ability of the banking system as a whole to play its vital role in supporting the savings and credit needs of households and businesses,” said Fed Chairman Jerome Powell during a Wednesday news conference.
“That is why, in response to these events, the Federal Reserve, working with the Treasury Department and the FDIC took decisive actions to protect the U.S. economy and to strengthen public confidence in our banking system,” he added.
In a statement about the increase, the Fed worked to reassure the public about the health of the banking system in light of SVB’s collapse. Of note, the interest rate decision was unanimous, with no dissenters.
“The U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain,” the Fed said.
The Fed statement also hinted that moves to rein in inflation are not over with this latest rate hike. It said the central bank will be closely monitoring incoming information but that the committee “anticipates that some additional policy firming may be appropriate.”
The Fed’s updated projections show that most members expect only one more 0.25 percentage point rate hike this year.
While annual inflation, as gauged by the consumer price index, fell to 6% for the year ending in February after it had been running at 6.4% the month before, the figure remains about three times higher than the Fed’s preferred level.
Some economists and corporate executives were hoping for the Fed to pause its rate hiking this week, and investors thought there was a chance that the central bank would do so. However, Fed Chairman Jerome Powell has made it clear that a return to price stability is a key mission of the central bank right now.
Boston Fed President Eric Rosengren said last week that the Fed should stop raising rates, given the events following SVB’s failure.
“Financial crises create demand destruction. Banks reduce credit availability, consumers hold off large purchases, businesses defer spending. Interest rates should pause until the degree of demand destruction can be evaluated,” Rosengren said.
Bill Ackman, a billionaire investor and the founder of Pershing Square, also supported holding rates steady, and Tesla CEO Elon Musk had encouraged the Fed to slash rates rather than increase them.
On Wednesday, the officials updated their projections for inflation. The median Fed official now sees inflation, as gauged by the personal consumption expenditures index, at 3.3% by the end of the year, compared to a December projection of 3.1%.
The Fed also upped its forecast for the unemployment rate in the coming months and years. It now predicts the unemployment rate will tick up to 4.5% by the end of this year, versus 3.6% today, an acknowledgment of the effects its tightening will have on the economy.
The committee members additionally revised down their GDP predictions for this year from 0.5% to 0.4% growth, indicating the growing likelihood that a recession will hit the economy in 2023.
Before Wednesday’s announcement, investors expected the Fed to cut rates over the course of 2023, bond market prices indicated.
Throughout the pandemic, the Fed kept rates at near zero for a historic amount of time. But the central bank’s rate target has risen quickly since it began tightening in March of last year. The campaign marks the most forceful rate hikes since the Great Inflation of the late 1970s and early 1980s.
The Fed does have some cushion to work with. The U.S. labor market is chugging along and, in some senses, defying gravity.
The economy added 311,000 jobs in February, more than expected, and the unemployment rate ticked up a bit to 3.6%, which is a very low figure by historical standards. The unemployment rate had previously dropped to a shocking 3.4%, the lowest since 1969.
But with this latest rate hike, and the bevy of other even more aggressive revisions over the past year or so, that red-hot labor market isn’t expected to hold. Economists expect unemployment to rise this year as the higher rates filter through almost every aspect of the economy.
There are concerns that the economy will fall into a recession, a fear that has only grown since the banking crisis began.
Last week, Goldman Sachs raised the chances of a recession in the U.S. to 35%, up 10 points from its previous prediction. The firm said the forecast reflects “increased near-term uncertainty around the economic effects of small bank stress.”