The Federal Reserve on Wednesday announced a modest quarter-point increase in its benchmark interest rate, an inflation-fighting hike that was scaled back as the Fed grapples with sudden turmoil in the banking industry.
The increase, the ninth in the past year, has brought interest rates to their highest levels since 2007. The Fed made the move despite concerns that it could worsen the banking upheaval after the collapses of two major banks and the rescue of a third in the past two weeks.
“Our banking system is sound and resilient, with strong capital and liquidity,” Fed Chairman Jerome Powell told reporters. “Inflation remains too high, and the labor market continues to remain very tight.”
The central bank warned that the banking distress is “likely to result in tighter credit conditions” and “weigh on economic activity, hiring and inflation.”
Bringing the benchmark interest rate to a range of 4.75% to 5% was one of the Fed’s most closely watched decisions in years. Rising interest rates typically lead to higher costs for mortgage loans, auto purchases, credit cards and business borrowing.
Mr. Powell said it’s too soon to determine whether the latest rate increase will affect banks or the hoped-for economic “soft landing” to avoid a recession.
Stocks plunged after Mr. Powell would not commit to cutting interest rates later this year. The Dow Jones Industrial Average closed down 530 points, or 1.6%, at 32,028. The S&P 500 and the Nasdaq indexes each lost 1.6%.
The Fed has been waging an aggressive campaign to lower inflation, which reached a four-decade high of 9.1% last summer. Republicans and some economists say Washington’s high spending under President Biden caused the problem, while Democrats blame corporate profiteering, the war in Ukraine and supply-chain complications.
Inflation declined in February to an annual rate of 6%, still far above the Fed’s target of 2%.
Mr. Powell signaled early in March that a half-point rate increase was likely needed to keep attacking inflation, which he said wasn’t coming down quickly enough. That was before the failure of Silicon Valley Bank in California on March 10 and New York’s Signature Bank, the second- and third-largest bank collapses in U.S. history, which led to fears of broader problems in the banking industry.
Economists say the bank failures were caused partly by the Fed’s rapid rate hikes, which decreased the value of long-term debt held by the banks and prevented them from raising enough cash when depositors sought withdrawals en masse. First Republic Bank last week received an emergency $30 billion infusion of deposits from 11 other big banks.
The Fed, the Federal Deposit Insurance Corp. and the Treasury Department agreed on March 12 to insure all the deposits at SVB and Signature beyond the normal $250,000 limit. The Fed also created a lending program to ensure that banks can access cash to repay depositors, if needed.
Economists warn that many midsize and small banks, to conserve capital, likely will become more cautious in their lending.
Mr. Powell said it’s too soon to determine the extent of the problems in the banking industry. The Fed and Congress are conducting multiple investigations into the collapse of SVB. Lawmakers will start hearings on Tuesday.
Sen. Tim Scott, South Carolina Republican and a member of the Senate Banking, Housing and Urban Affairs Committee, said one of the failures affecting banks is “the Biden economy.”
“It’s a challenge when you go to a 40-year high in inflation, hitting 9.1%,” Mr. Scott told the American Bankers Association meeting in Washington this week. “When inflation is that high, you should expect immediate, hard action from the Fed. And the Fed does not have a scalpel. They only have a hammer. And when they use the hammer, it hurts. And so I think that contributes to the failure of the institutions.”
Committee Chairman Sherrod Brown, Ohio Democrat, told the American Bankers Association that lawmakers likely will consider imposing more regulations on the banking industry. He mentioned stress tests, liquidity requirements and capital standards as policy areas “where most of the action will be.”
“We’re not going to slow-walk, but we’re not going to rush into it, either,” Mr. Brown said.
Treasury Secretary Janet Yellen told a Senate Appropriations subcommittee Wednesday that the banking system is sound and that the administration took the actions “to mitigate risks to the banking system.”
“It’s important to be clear: Shareholders and debt-holders of the failed banks are not being protected by the government,” she said. “And no losses from the resolution of these banks are being borne by the taxpayer.”
Mr. Powell said he believes SVB’s management “failed badly.” He said the problem was compounded by social media and a group of bank depositors who were connected to one another in the technology industry, contributing to an “unprecedentedly rapid bank run” in which customers tried to withdraw $42 billion in a single day.
“It’s clear that we do need to strengthen supervision and regulation” of the industry, Mr. Powell said.
In a statement, the Fed’s Open Market Committee said the U.S. banking system “is sound and resilient,” but officials referred indirectly to the failures of the two banks as influences on their unanimous decision.
“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 statement from the rate-setting committee said.
Fed officials forecast that they will raise interest rates to 5.1% by the end of this year, unchanged from the Fed’s estimate in December and suggesting just one more rate hike this year. They softened their language about future rate increases.
“We no longer state that we anticipate that ongoing rate increases will be appropriate to quell inflation,” Mr. Powell said. “Instead, we now anticipate that some additional policy firming may be appropriate.”
Mr. Powell said the central bank is “trying to reflect the uncertainty of what will happen” from its latest rate increase. He said the potential tightening of credit essentially could have the same impact as another rate hike.
Other major central banks are also seeking to tame high inflation without worsening the financial instability caused by the two U.S. bank collapses and the hasty sale of troubled Credit Suisse to UBS. Even with the anxieties surrounding the global banking system, for instance, the Bank of England faces pressure to approve an 11th straight rate hike Thursday with annual inflation having reached 10.4%.
The European Central Bank, saying Europe’s banking sector was resilient, last week raised its benchmark rate by a half point to combat an inflation rate of 8.5%. At the same time, the ECB president, Christine Lagarde, has shifted to an open-ended stance regarding further rate increases.
In the U.S., most data still points to a solid economy and strong hiring. Employers added a robust 311,000 jobs in February. Although the unemployment rate rose from 3.4% to a still-low 3.6%, that mostly reflected an influx of job-seekers who were not immediately hired. In its latest quarterly projections, the Fed predicts that the unemployment rate will rise from 3.6% to 4.5% by year’s end.
• This article is based in part on wire service reports.
• Dave Boyer can be reached at dboyer@washingtontimes.com.
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