Fed hikes interest rates again despite concerns of a looming recession

“My colleagues and I understand the hardship that high inflation is causing and we remain committed to bringing inflation back down to our 2 percent goal,," Federal Reserve Chair Jerome Powell said.Al Drago/Photographer: Al Drago/Bloomberg

Despite slowing economic growth, another bank failure, and a showdown over the debt limit, Federal Reserve officials Wednesday raised a key interest rate for the third time this year but signaled it might be the last one for a while.

The quarter percentage point increase, the 10th straight hike by the Fed’s monetary policy committee, underscored how officials are prioritizing their fight against still-elevated inflation over fears that higher borrowing costs will push the nation into a recession. The central bank’s benchmark rate is now between 5 percent and 5.25 percent, the highest since 2007.

The rate has reached the level the Fed had projected for the end of 2023, and analysts expect officials to hold off on any more increases in order to gauge how the tighter credit conditions affect an economy being buffeted by strong headwinds.

In a statement, the Fed said it would “closely monitor” incoming economic data and take into account a delayed effect from the higher rates in “determining” whether additional increases are necessary. That wording was softer than in its last statement in March, when the Fed said it anticipated additional hikes might be appropriate.

In a news conference after the announcement, Fed Chair Jerome Powell reiterated the central bank’s commitment to bringing down inflation.

“My colleagues and I understand the hardship that high inflation is causing and we remain committed to bringing inflation back down to our 2 percent goal,” he said. The rate increases are having an impact, particularly on home sales given higher mortgage rates, Powell said, but it will take more time to see the full effects.

Fed officials voted unanimously for Wednesday’s rate increase. Powell said some members talked about a pause in the hikes going forward but no decision was made about that issue.

“There’s a sense that we’re much closer to the end of this than to the beginning,” he said of the cycle of rate hikes that began in March 2022. “We feel like we’re getting close or maybe even there, but then again that’s going to be an ongoing assessment.”

Still, Oxford Economics, a global forecasting and analysis firm, said the Fed sent a “clear signal” that it won’t be raising the rate again at its next meeting in June.

“A pause in June would buy the Fed time to gauge how the recent stress in the banking system will weigh on the economy via tighter lending standards, which creates uncertainty in the outlook for growth and inflation,” Oxford said in an e-mail to its clients.

Major stock indexes turned negative Wednesday afternoon after Powell said he did not foresee any rate cuts in the near future as inflation will take time to get back to normal.

The Fed’s interest rate was near zero in March 2022 when Fed officials began aggressively hiking it to curb fast-rising prices amid criticism they had initially dismissed higher inflation as only a temporary reaction to reopening the economy after pandemic shutdowns. The consumer price index hit a 9.1 percent annual rate last June, the highest in more than four decades.

Banks use the Fed interest rate to set borrowing costs for consumer and business loans. Higher interest rates have led to reduced consumer demand, helping lower inflation in recent months. The consumer price index was down to a 5 percent annual rate in March and the Fed’s preferred inflation metric was a bit lower at 4.6 percent, although still more than double the central bank’s target of 2 percent a year.

Rising interest rates also have hit the economy more broadly. Since Fed officials last met in March, the government reported that US economic growth slowed significantly in the first quarter of the year. The nation’s total output, known as gross domestic product, grew at a weak 1.1 percent annual rate from January through March, down from 2.6 percent in the previous quarter.

A recession is generally when the economy contracts for two consecutive quarters, although there are other factors in making an official declaration. Many economists expect the United States to fall into a recession this year.

Job growth also has been slowing in recent months, although it has remained solid and the unemployment rate was a historically low 3.5 percent in March. The Labor Department will release the April jobs data on Friday. A key report on private-sector employment from payroll processing firm ADP on Wednesday showed strong growth last month, with 296,000 jobs added.

On top of that, recent regional bank failures — including the collapse and sale of First Republic Bank over the weekend — have roiled financial markets and caused lenders to be more cautious.

Powell declared that the US banking system “is sound and resilient” and that conditions in that sector have improved since the failures of Silicon Valley Bank and Signature Bank in March. The Fed released a report last week criticizing its own oversight of Silicon Valley Bank and Powell said, “We’re committed to learning the right lessons from this episode and we’ll work to prevent events like these from happening again.”

More market turmoil could be coming. The White House and congressional Republicans remain at a stalemate over raising the nation’s debt limit as Treasury Secretary Janet Yellen warned this week that a first-ever government default is possible as soon as June 1 if the limit is not raised.

“Everything the Fed looks at, to me, is saying loudly, ‘stop’ ” raising interest rates, said Mark Zandi, chief economist at Moody’s Analytics, an economics research and consulting firm. “Inflation is moderating. The economy is slowing. We’ve got a banking crisis that required a full government backstop to quell . . . and now you have the debt limit thrown in the mix.”

Those swirling economic risks led Senator Elizabeth Warren, a Massachusetts Democrat, and nine other progressive lawmakers to write to Powell on Monday urging the Fed not to hike the rate at this week’s meeting.

“While the labor market has remained resilient to the Fed’s aggressive interest rate hikes and inflation is down from its peak last year, recent turmoil in the banking system following the failures of Silicon Valley Bank and Signature Bank and the lagging impacts of the Fed’s earlier rate hikes leave our economy even more vulnerable to an overreaction by the Fed,” they wrote.

Warren, a frequent critic of Powell, said on CNBC after the Fed announcement that, “I just think it’s the wrong direction.”

The Fed’s staff forecast in March that the country would have a mild recession this year, according to minutes of that meeting. Powell said he did not necessarily agree, but quickly noted he was not completely ruling out the possibility of a recession.

“The case [for] avoiding a recession is, in my view, more likely than that of having a recession,” he said, noting that job growth has been slowing so far without a rise in unemployment.

Powell was clear on the threat to the economy if Congress does not raise the debt limit.

“No one should assume that the Fed can protect the economy from the potential short-and long-term effects of a failure to pay our bills on time,” he said.