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Inflation is proving to be one persistent villain — and that, more than the recent tumult in the banking system sparked by the collapse of Silicon Valley Bank, remains the biggest threat to the US economy.
The latest evidence arrived on Tuesday, when the government’s consumer price index report for February showed costs for many goods and services were still climbing at a pace that is too fast for comfort — ours and the Federal Reserve’s, whose job description includes trying to prevent every trip to the supermarket from being an agita-inducing episode.
The central bank has spent the past year aggressively hiking interest rates in a bid to halt the upward spiral in the cost of living, and it’s had some success. Inflation has come down from the more than 9 percent annualized peak reached last June, and Fed officials have vowed to push rates up to the point where it’s clear that the foe has been defeated.
But the failure of Silicon Valley Bank last Friday, followed by the shutdown of Signature Bank on Sunday, has complicated the Fed’s mission. Financial markets remain on edge even after federal regulators stepped in Sunday night to guarantee all deposits at both banks, including those above the standard $250,000 limit. And consumer confidence may have been shaken by the news of bank runs.
It’s not an ideal time to be boosting the cost of borrowing.
The CPI recorded a 6 percent increase last month, down from a 6.4 percent annual pace in January, according to the US Bureau of Labor Statistics. But that’s still nowhere near the 2 percent rate the Fed considers optimal for a smooth-running economy.
“Inflation is not going away fast enough,” Bloomberg economists Anna Wong and Stuart Paul said in a research note. “There remains a compelling need for the Fed to continue raising rates.”
There had been no doubt earlier this month that Fed officials would once again tighten credit at their meeting next Tuesday and Wednesday. That’s because hiring in February was far stronger than analysts had forecast, pointing to solid economic growth despite the Fed’s efforts to cool things down.
“The labor market remains extremely tight,” Fed chair Jerome Powell said in his semiannual testimony to the Senate last week. Powell has argued just about every time he speaks that inflation won’t return to pre-pandemic levels until the economy softens enough that employers slow hiring and cut workers.
The only question he left unanswered was whether the Fed’s next step — after having boosted rates by 4.5 percentage points in a year — would be the same quarter-point increase it made six weeks ago, or a half-point move, which would signal heightened concern that progress on inflation had stalled.
But the banking blowups have complicated the Fed’s decision.
Investors have a litany of lingering concerns, including the negative impact on bank profits from rising interest rates and large unrealized losses on banks’ bond investment, also caused by high rates.
Moody’s Investors Service on Tuesday downgraded its outlook for the banking sector to negative from stable, citing “the rapid deterioration in the operating environment” following the bank failures and the decision last week by Silvergate Capital, a lender to crypto companies, to voluntarily liquidate after a run by depositors.
Because the Fed pays close attention not only to price stability, but also to stability of the financial system, some analysts believe policy makers will hold off on a rate increase next week in order to let the dust settle.
“The Fed has to bite the bullet a little and be more patient on the inflation battle,” said Brian Bethune, an economist at Boston College, who argues that the higher rates already put in place by the central bank need more time to work through the economy. “We don’t want to win the battle by precipitating a bank liquidity/solvency crisis, and then lose the war by nosediving into recession.”
But Megan Greene, global chief economist at Kroll Institute, expects the Fed won’t pause, because higher interest rates weren’t the main reason the three banks folded.
Rather, she said, they were outliers with high concentrations of uninsured deposits pouring in from flush tech and crypto customers, and because they invested so much of those deposits into long-term bonds that lose value when interest rates are rising. Silicon Valley Bank took an even bigger risk by failing to hedge its bond holdings.
“Most banks extend loans rather than buy bonds and have a client base that is more diverse and less reliant on interest rates being low,” she wrote in a note to clients in which she predicted the Fed would lift rates by a quarter point.
Her view that Silicon Valley Bank and the others were exceptions rather than the rule for lenders was supported on Tuesday as bank stocks rallied, driving the broader market higher, an indication that Wall Street may believe the worst of the turmoil is over.
Moreover, the latest CPI report wasn’t all bad.
Besides the slowdown compared with a year ago, inflation rose at a modestly milder pace in February from the previous month. Meats, poultry, fish, and eggs fell 0.1 percent over the month, the first decrease since December 2021. And the so-called core index, which the Fed prefers as a gauge because it excludes volatile food and energy prices, rose 5.5 percent over the past year, the smallest increase since December 2021.
But numbers like that would have been inconceivable before the advent of COVID, when inflation was often below the Fed’s 2 percent target.
“We have covered a lot of ground, and the full effects of our tightening so far are yet to be felt,” Powell said in his Senate testimony. “Even so, we have more work to do.”
There is likely nothing in the new inflation data that would change Powell’s mind.