The Federal Reserve of the United States has hiked interest rates yet again, despite concerns that the move may exacerbate financial upheaval following a string of bank collapses.
The Federal Reserve lifted the key interest rate by 0.25 percentage point, calling the financial industry “sound and healthy.”
Yet, it warned that the ramifications of bank failures could have a negative impact on economic development in the coming months.
To keep prices stable, the Fed increased borrowing costs.
Yet, the sharp rise in interest rates since last year has put the financial sector under strain.
Two American banks failed this month, Silicon Valley Bank and Signature Bank, in part due to obstacles posed by rising interest rates.
Concerns have been raised concerning the value of bank bonds, which may become less valuable as interest rates rise.
Banks typically keep enormous bond portfolios and, as a result, are sitting on significant potential losses. Falling bond values are only necessarily a concern once banks are obliged to sell them.
Authorities worldwide have stated that they do not believe the failures threaten global financial stability and that they should be used to divert attention away from attempts to curb inflation.
Last week, the European Central Bank raised its key interest rate by 0.5 percentage points.
The Bank of England is set to make its own interest rate decision on Thursday, a day after official numbers revealed that inflation unexpectedly rose to 10.4% in February.
Chair of the Federal Reserve, Jerome Powell stated that the Fed was committed to fighting inflation. He referred to Silicon Valley Bank as an “outlier” in an otherwise robust financial system.
Yet, he recognized that the recent instability was likely to slow growth, with the full extent of the impact still unknown.
What does this mean for the economy
According to the bank’s forecasts, the economy would grow by 0.4% this year and 1.2% next year, a significant slowdown from the usual – and less than policymakers predicted in December.
The Fed’s announcement also softened previous pronouncements that stated “ongoing” interest rate increases would be required in the coming months.
The Fed instead stated, “Some more policy firming may be needed.”
According to Ian Shepherdson, chief economist at Pantheon Macroeconomics, the changes “obviously imply that the Fed is worried.”
The Fed raised interest rates for the eighth time in a row on Wednesday. It raises its main interest rate from near zero to 4.75%-5%, the highest level since 2007.
Rising interest rates increase the cost of purchasing a home, borrowing to expand a business, or incurring other debt.
The Fed anticipates that demand will fall by making the such activity more expensive, causing prices to fall.
It has begun to happen in the US housing market, where purchases have slowed considerably in the last year, and the median sales price in February was lower than a year ago – the first such drop in more than a decade.
Yet, the economy has performed better than projected, and prices are rising faster than the 2% rate considered healthy.
Inflation increased by 6% in the year to February. As a result, certain products, such as food and airfare, are becoming even more expensive.
Mr. Powell had cautioned before the bank failures that officials could need to raise interest rates more than expected to bring the situation under control.
According to bank predictions, policymakers expect inflation to fall this year, but less than they did a few months ago.
Yet, they anticipated interest rates of around 5.1% at the end of 2023, which has been steady since December, signaling the Fed is ready to cease hiking rates soon.
Mr. Powell described the recent volatility as having the “equivalent of a rate hike.”
He believes the Fed can raise its primary rate less aggressively if financial system turbulence causes banks to reduce lending and the economy to slow more swiftly.
But, he reiterated that the Fed would not back down from its fight against inflation.
The Bank of England will raise interest rates in May
In May, the Bank of England’s chief economist hinted at another interest rate hike when he stated the central bank needed to “see the job through” in its fight against high inflation. On the other hand, Huw Pill emphasized that the Monetary Policy Committee had a difficult decision on whether to raise interest rates from 4.25 percent, especially in light of financial market volatility.
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Pill has always voted with the majority on the committee that sets borrowing costs since joining the central bank in September 2021. Financial markets share his nuanced statements on interest rates, which expect interest rates to peak at 4.5% but are split about 50:50 on whether the rate hike would occur at the next meeting in early May. Pill emphasized that he was looking closely at the risk of high inflation becoming persistent in the UK, with companies hiking prices and people demanding bigger pay increases to avoid losing income. But, according to him, there was no evidence in UK data of either excessive profiteering or salary increases.
