With new interest rate hike, the Fed signals health of the US financial system

Powell says banking turmoil could have similar effect on the economy as another quarter-point rate hike.

The Federal Reserve raised interest rates by one-quarter of a percentage point on Wednesday.STEFANI REYNOLDS/NYT

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Assessing the recent string of bank failures, the Federal Reserve said on Wednesday that the US financial system is “strong and resilient” — healthy enough to absorb further increases in borrowing costs as it labors to bring down inflation.

After raising its benchmark federal funds rate by one-quarter of a percentage point, the central bank hinted that the turmoil triggered by the collapse of Silicon Valley Bank of California and New York’s Signature Bank could actually help in its anti-inflation fight.

“Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation,” the Fed said in a statement after wrapping up a two-day meeting in Washington.

In other words, banks will probably try to conserve capital by making fewer loans, leading to a squeeze that could slow consumer spending and cool off the overheated job market.

Just how hard the economy will be hit “is uncertain,” the Fed said.

The central bank’s widely anticipated quarter-point rate hike, its ninth consecutive increase, is an attempt to continue efforts to rein in inflation without putting too much pressure on the economy with a larger increase.

Prior to the banking blowup, there was a decent chance the Fed would approve a half-point increase because recent data had shown that the labor market remained red hot and consumer prices were edging higher again.

At a post-meeting news conference, Fed chair Jerome Powell said the fallout from the banking mess could amount to the equivalent of a rate hike or more. Fresh economic forecasts released by the Fed also suggested it could boost rates at least once more by a quarter-point.

Bank shares led the stock market higher over the past two days on the absence of any fresh bad news about deposit withdrawals or investment losses. Stocks shot up initially on the Fed’s action, but then gave back most of those gains within an hour.

It will take the financial world some time to digest the full implications of the Fed’s decision.