Fed raises key rate despite turmoil, vows to keep up inflation fight

Powell acknowledged that some banks may reduce their pace of lending at a time of high anxiety in the financial system. Any such pullback in lending, he said, could slow the economy and possibly act as the equivalent of an additional quarter-point rate hike.

“Events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses,” the Fed chair said. “It is too soon to determine the extent of these effects and therefore too soon” for the Fed to know how or whether its plans for interest rates might be affected.

At the same time, the Fed warned that the financial upheaval stemming from the collapse of two major banks is “likely to result in tighter credit conditions” and “weigh on economic activity, hiring and inflation.”

Wall Street jumped after the announcement before falling into negative territory. The benchmark S&P 500 was 0.1 per cent higher at 6.43am AEDT, the Dow Jones lost 0.7 per cent and the Nasdaq dropped by 0.4 per cent.

The latest rate hike suggests that Powell is confident that the Fed can manage a dual challenge: Cool still-high inflation through higher loan rates while defusing the financial upheaval in the banking sector through emergency lending programs and the Biden administration’s decision to cover uninsured deposits at two failed US banks.

The Fed’s decision to signal that the end of its rate-hike campaign is in sight may also soothe financial markets as they continue to digest the consequences of US banking turmoil and the takeover last weekend of Swiss bank Credit Suisse by its larger rival.

The Fed’s benchmark short-term rate has now reached its highest level in 16 years. The new level will likely lead to higher costs for many loans, from mortgages and auto purchases to credit cards and corporate borrowing. The succession of Fed rate hikes have also heightened the risk of a recession.

The Fed’s latest decision, after a two-day policy meeting, reflects an abrupt shift. Early this month, Powell had told a Senate panel that the Fed was considering raising its rate by a substantial half-point. At the time, hiring and consumer spending had strengthened more than expected, and inflation data had been revised higher.

In its statement, the Fed included some language that indicated that its fight against inflation is still far from complete. It said that hiring is “running at a robust pace” and noted that “inflation remains elevated.” It removed the phrase, “inflation has eased somewhat,” which it had included in its statement in February.

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The troubles that suddenly erupted in the banking sector two weeks ago likely led to the Fed’s decision Wednesday to impose a smaller rate hike. Some economists have cautioned that even a modest quarter-point rise in the Fed’s key rate, on top of its previous hikes, could imperil weaker banks whose nervous customers may decide to withdraw significant deposits.

Silicon Valley Bank and Signature Bank were both brought down, indirectly, by higher rates, which pummeled the value of the Treasurys and other bonds they owned. As anxious depositors withdrew their money en masse, the banks had to sell the bonds at a loss to pay the depositors. They were unable to raise enough cash to do so.

After the fall of the two banks, the Swiss bank Credit Suisse was taken over by its larger rival UBS last weekend. Another struggling bank, First Republic, has received large deposits from its rivals in a show of support, though its share price plunged Monday before stabilising.