Federal Reserve Hikes Its Key Interest Rate A Quarter Point

The Federal Reserve is raising its key interest rate 0.25 percentage point, underscoring central bankers' commitment to fighting inflation even if that heightens the financial pressure on the country's banks.

The Fed's benchmark rate is rising to a range between 4.75% and 5%, the bank's rate-setting body said Wednesday in a statement. That's the highest level for the federal funds rate since 2006.

The sudden collapse of Silicon Valley Bank on March 10 and of New York's Signature Bank two days later has spurred fear that worried depositors could rush to withdraw their money from other regional lenders, sparking a wider crisis.

Bank wobble leads Fed to back off

As recently as two weeks ago, the Fed appeared set for a steeper rate hike and and prepared to keep them elevated for longer. But a a startling deposit run at Silicon Valley Bank, closure of two smaller banks and takeover of two others created panic in the financial system. Many economists, as well as the Fed, noted that banks' newfound caution following the turmoil would likely drag on the economy.

"Before the recent events, we were clearly on track to continue with ongoing rate hikes. In fact, as of a couple weeks ago, it looked like we'd need to raise rates over the course of the year more than we expected," Federal Reserve Chair Jerome Powell said in news conference.

"The events of the last two weeks are likely to result in some tightening of credit conditions for households and businesses and, thereby, weigh on demand on the labor market and on inflation," Powell added. "In principle, as a matter of fact, you can think of it as being the equivalent of a rate hike, or perhaps more than that. Of course, it's not possible to make that assessment today with any precision whatsoever," he said.

Powell also sought to calm fears about the stability of the broader banking system.

"Our banking system is sound and resilient with strong capital and liquidity. We will continue to closely monitor conditions in the banking system and are prepared to use all of our tools as needed to keep it safe and sound," he said.

Silicon Valley Bank and Signature Bank were both brought down, indirectly, by higher rates, whose rapid rise hurt the value of the Treasury bonds and mortgage-backed bonds they owned. As anxious depositors withdrew their money en masse, the banks had to sell the bonds at a loss to pay depositors. 

Recession coming?

The Fed's latest policy statement signals its shift from fighting inflation at all costs to a more delicate balance between trying to bring down prices while tightening credit in ways that might further sap public confidence in banks and hurt the economy.

"A dovish rate hike was delivered from the Fed today as they attempt to balance the risks of price stability and fighting inflation," Charlie Ripley, senior investment strategist for Allianz Investment Management said in a note. "Not signaling a higher terminal rate should send a message to market participants that the economy may be weaker than recent economic data suggests."

But with economic growth already subdued, even the small rate hike risks tipping the U.S. into a recession and driving the unemployment rate higher, economists said.

"Even before the [banking] crisis we thought the economy was at high risk of recession this year and, with recent events likely to hit confidence and result in a significant further tightening in credit conditions we are more confident in that view now," Andrew Hunter, deputy chief U.S. economist at Capital Economics, said in a report. "[W]ith the crisis making us more confident in our view that the economy will fall into recession soon, we suspect the Fed will be cutting rates again before too long."

First published on March 22, 2023 / 2:02 PM

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