The Federal Reserve raised its key interest rate another quarter of a percentage point on Wednesday in its ongoing bid to crush inflation, but indicated it could pause the increases to assess the impact of monetary tightening on the U.S. economy.
The Fed’s rate-setting body said it would raise its benchmark rate to a range between 5% and 5.25%, the highest level since 2007. The increase is the 10th straight interest-rate hike since last March in what has been the most aggressive rate-hiking regime since the 1980s.
Higher interest rates act on inflation by making it more expensive for businesses and consumers to borrow money, slowing economic activity. Many economists have been calling on the Fed to pause its current rate-hiking regime to avoid pushing the economy into a recession and, more recently, raising pressure on the banking sector.
In its statement issued Wednesday, the Federal Open Markets Committee signaled this could be the last increase, deleting a reference to “future increases” that appeared in prior statements and noting that “Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring and inflation.”
Instead, it said its policymaking committee “will closely monitor incoming information and assess the implications for monetary policy.
“In determining the extent to which additional policy firming may be appropriate to return inflation to 2% over time, the Committee will take into account” its rate hikes so far, the lags with which they affect the economy and inflation, and “economic and financial developments.”
Still, if inflation and the labor market show signs of cooling down sufficiently by the Fed’s mid-June meeting, as many economists expect, Fed officials appear inclined to halt the rate increases.
Otherwise, they could bump up rates again despite the growing risk that the moves will trigger a mild recession later this year.
The Fed repeated that it will also consider the effects of the Silicon Valley Bank crisis, which has prompted banks to tighten lending standards and that’s likely “to weigh on economic activity, hiring and inflation. The extent of these effects remains uncertain.”
In other words, if it’s tougher for consumers and businesses to borrow, that could lessen the need for more rate increases.
“In principle, we won’t have to raise rates quite as high as we would have if (the banking crisis) hadn’t happened,” Powell said.
So has the central bank reached its peak interest rate?
“We may not be far off and are possibly even at that level,” he said, adding that will depend on how economic activity and inflation evolve.
At a press conference, Powell said: “There is a sense that, you know, we’re much closer to the end of this than to the beginning.” But he warned that “future policy actions will depend on how events unfold”.
Congress is currently at loggerheads over the government’s borrowing limit and Powell said it was “essential” an agreement was reached. “No one should assume that the Fed can protect the economy from the potential short- and long-term effects of a failure to pay our bills on time,” he said.
In March, the annual inflation rate was 5%, down from its peak of 9.1% in June and its lowest rate since 2021. Inflation has steadily declined over the last few months but remains well above the Fed’s target rate of 2%.
Though overall inflation has been cooling over the last few months, much of the tapering off was seen in the volatile energy sector, which a year ago saw price jumps following Russia’s invasion of Ukraine.
Core inflation, which excludes the more volatile energy and food prices, went up slightly in March as housing prices rose 8.2% over the last year. Fed officials have probably been paying attention to that issue alongside signs that the jobs market remains robust. In March, 236,000 jobs were added to the labor market.
According to data from the CME Group, Wall Street traders were betting that the Fed would announce another 0.25% rate hike — but that it will be forced to cut rates at least twice before the end of the year as economic growth slows to a crawl.
Others disagreed about how exactly this all plays out. In an emailed statement, Seema Shah, the chief global strategist at Principal Asset Management, said that with inflation still elevated and sticky and with the broad economic picture still looking “fairly robust,” the Fed would be more likely than not to keep additional rate hikes on the table.
“Provided the economic data slows only gently and inflation remains elevated, and the banking sector volatility is fairly contained, we think a June hike is still possible,” she wrote. “Indeed, we believe there is a higher risk of a rate hike in June than what the market is currently pricing in.”
Those forecasts were countered elsewhere. Heading into Wednesday, the chorus of voices calling for the Fed to pause kept growing. On Tuesday, Sen. Elizabeth Warren, D-Mass., and Rep. Pramila Jayapal, D-Wash., called on Fed Chair Jerome Powell to halt rate hikes entirely, warning that too many increases would cost a growing cohort of people their jobs.
“We believe that continuing to raise interest rates would be an abandonment of the Fed’s dual mandate to achieve both maximum employment and price stability and show little regard for the small businesses and working families that will get caught in the wreckage,” they wrote.
Analysts at Nomura global financial services group offered something of a middle ground: While they forecast the Fed would raise the rate by the expected 0.25%, they said it will prove a “dovish hike” as the central bankers replace previous language that signaled additional hikes will be necessary, planning to take a more wait-and-see approach.
Perhaps the best summation of the economic crosswinds facing the Fed was found in an anonymous response to the monthly report from the Institute for Supply Management, which showed a modest increase in sentiment among producers for April.
“We seem to be in a season of contradictions,” said the respondent, identified only as an executive at a metals manufacturing firm. “Business is slowing, but in some ways, it isn’t. Prices for some commodities are stabilizing, but not for others. Some product shortages are over, others aren’t. Trucking is more plentiful, except when it isn’t. There’s uncertainty one day, but not the next. The next couple of months should provide answers — or not. It’s hard to make projections at the moment.”
For Shah, the prevailing crosscurrents signal the worst outcome of all.
“The most dangerous risk for financial markets currently is stagflation — the risk of the Fed failing to deliver sufficient tightening, permitting a resurgence in inflation later on in the year,” she wrote.
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