WASHINGTON — Federal Reserve officials on Wednesday resisted pressure to pause their inflation-fighting efforts in the wake of two bank failures, voting unanimously to raise interest rates again.
The quarter-percentage point increase, the Fed’s most pivotal interest rate decision in years, came just days after the failures of Silicon Valley Bank and Signature Bank shook the industry, roiled financial markets, and forced federal intervention to prevent a broader contagion.
“The US banking system is sound and resilient,” the Fed’s monetary policy-making committee said in its statement announcing the rate hike.
The banking turmoil is likely to make obtaining consumer and business loans more difficult, which could hurt the economy by slowing spending and hiring, the Fed said. But that also could help tamp down inflation, it added.
After the latest increase, the Fed’s benchmark interest rate is now at a target of between 4.75 percent and 5 percent. In updated economic projections also released Wednesday, Fed officials indicated they would hike the rate once more this year, to top out at just above 5 percent — although that doesn’t mean fast-rising increases in prices will revert to normal any time soon.
“Inflation remains too high,” Fed Chair Jerome Powell said at a news conference. “The process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy.”
Major stock indexes rose on the Fed’s rate hike announcement but then began retreating as Powell was speaking and ended down about 1.6 percent for the day.
“Powell’s tenor was significantly more tentative and less confident than he was in February,” Diane Swonk, chief economist at audit and consulting firm KPMG, said in a note sent to clients. “The crisis has clearly shaken him. He was careful to leave all policy options on the table.”
Fed officials had to weigh continuing their aggressive fight on still-high inflation against concerns about the stability of US banks, whose finances have been rocked by those fast-rising interest rates over the past year.
For some critics of the rate hike effort over the past year, the collapse of the banks adds to their fears that the Fed’s push could destabilize the broader economy. But Powell said that despite the banking problems he still thought the Fed could tame inflation without triggering a recession, executing what economists call a “soft landing.”
“It’s too early to say whether these events have had much of an effect. It’s hard for me see how they would have helped the possibility,” he said. “I think that pathway still exists [to a soft landing] and we’re certainly trying to find it.”
Investors overwhelmingly anticipated a quarter-point increase in the aftermath of the bank failures. But Powell and his colleagues were pressed by Massachusetts Senator Elizabeth Warren and other Democratic lawmakers to pause the rate hikes completely to allow the banking sector to stabilize and prevent the economy from tipping into a recession.
Powell said officials considered a pause but decided incoming economic data still warranted a small rate hike.
Because Fed officials are prohibited from speaking publicly for 10 days before a monetary policy meeting, Powell answered questions Wednesday for the first time since Silicon Valley Bank collapsed on March 10. Fed officials oversaw the bank, which with $209 billion in assets was the second-largest bank failure in US history.
“We are committed to learning the lessons from this episode and to work to prevent . . . events like this from happening again,” he said in seeking to assure the public about the safety of their bank deposits. He noted the Fed has launched an internal review and he welcomed outside investigations, which he said are standard when a bank fails.
“The question we were all asking ourselves over that first weekend was how did this happen,” he said of Silicon Valley Bank’s sudden failure. But he described the bank as “an outlier” because of its high percentage of uninsured deposits and extensive holdings of long-term bonds that lost value as interest rates have risen.
Powell has faced sharp criticism for allowing the collapse on his watch as well as reducing oversight of large regional banks with new discretion given to the Fed by a 2018 law that eased some tough regulations put in place after the financial crisis a decade earlier.
“He has had two jobs: One is to deal with monetary policy, one is to deal with regulation. He has failed at both,” Warren said of Powell on NBC’s “Meet the Press” Sunday. “I don’t think he should be chairman of the Federal Reserve.”
Higher interest rates were a key factor in the failure of Silicon Valley Bank because they reduced the value of its long-term bonds. The bank’s failure led officials at the Fed, the Treasury Department, and the Federal Deposit Insurance Corp. to announce they would guarantee deposits above the $250,000 FDIC limit and offer banks loans on their devalued long-term bonds so they would have the cash to keep operating if a wave of customers sought withdrawals.
Silicon Valley Bank, which was among the largest and most influential banks for Boston-area startups, had a heavy focus on technology companies that made it highly vulnerable when the sector ran into financial trouble. Powell said the bank’s manager didn’t properly protect its finances against potential declines in the value of its long-term investments.
“At a basic level, Silicon Valley Bank’s management failed badly,” Powell said. “They grew the bank very quickly, they exposed the bank to significant liquidity risk and interest rate risk, [and] didn’t hedge that risk.”
Fed banking supervisors saw the risks and intervened but were unable to prevent the failure, he said.
As part of its review, Fed officials also plan to study the “unprecedentedly rapid and massive bank run” by Silicon Valley Bank’s depositors who scrambled to withdraw their money and determine if new regulations or procedures are needed to prevent a repeat, he said.
With inflation spiking toward a four-decade high early last year, Fed officials began raising their benchmark short-term interest rate to try to slow price growth by reducing demand. The Fed now has raised the rate, which affects what lenders charge for credit card, auto, and other loans, at nine consecutive meetings from the near-zero level designed to spur growth during the pandemic to the current level.
It’s been the most aggressive set of rate hikes since the last major battle against high inflation in the late 1970s and early 1980s and risks pushing the US economy into a recession. Higher rates make it more expensive to buy a car or house while adding to costs for businesses to expand and hire, theoretically cooling inflation by driving down demand but potentially adding pain to the economy elsewhere.
The annual inflation rate has slowed significantly from 9.1 percent in June to 6 percent in February, as measured by the consumer price index. Still, that remains well above the Fed’s preferred 2 percent level.
The Fed had boosted rates by a half or even three-quarters of a percentage point — unusually large increases — for six straight meetings before letting up in December with a quarter-point hike as monthly inflation was easing and job growth was slowing. A reversal of those trends in the new year added pressure on Fed officials to return to more aggressive interest rate increases until the bank failures complicated their strategy.