Federal Reserve raises benchmark rate by 0.25 point despite bank turmoil

The Federal Reserve raised interest rates by a quarter of a percentage point on Wednesday, moving forward with its fight against high inflation after taking dramatic steps to contain a banking crisis.

Less than two weeks after the collapse of Silicon Valley Bank and Signature Bank jarred the nation’s financial stability, Federal Reserve Chair Jerome H. Powell said the banking system had stabilized, and that officials were confident there would not be more bank runs. The Fed has turned to finding out what caused such a significant failure. But Powell said that the Fed’s efforts to slow the economy continue, and stress in the financial markets may even help that effort.

“You can think of it as being the equivalent of a rate hike or perhaps more than that. Of course, it’s not possible to make that assessment today with any precision whatsoever,” Powell said.

The central bank is also facing questions about its regulatory oversight of SVB, as Washington tries to figure out whether the government could have prevented the turmoil in the banking sector. Powell said that as the Fed tried to understand “how did this happen,” focus shifted to “what are the right policies to put in place, so it doesn’t happen again.” Management at SVB “failed badly,” Powell said, even while regulators were aware of problems and tried to intervene.

The Fed has undertaken an internal investigation, and Powell said he would “welcome” an outside investigation. But it remains to be seen whether or how the Fed will change its own regulations to prevent a similar shock. Pressure is mounting on Capitol Hill for the central bank to explain how its policies made it possible for SVB to fail, threaten the broader economy and necessitate emergency action.

“What went wrong here? How did this happen?” Powell said. “We will find that and then make an assessment of what are the right policies to put in place so that it doesn’t happen again.”

Before SVB’s meltdown, Powell had warned that the economic data was coming in hotter than expected. The job market was white hot, and inflation wasn’t falling at a rapid clip. That put the Fed on track for a slew of rate hikes in 2023.

But the economic picture quickly changed, and financial conditions tightened as the banking system took a hit. Powell said the result was equivalent to a rate hike, “or perhaps more than that.” Policymakers considered pausing rate hikes on Wednesday, but ultimately decided to move forward with a quarter-point hike as they prepare to stop sometime soon.

In a fresh crop of economic projections, officials penciled in one more quarter-point rate increase this year, though future moves depend heavily on how the economy behaves. Officials otherwise made small tweaks to their previous estimates from December. They now expect the unemployment rate to end the year at 4.5% (down from 4.6% the last time the bank made projections) and that the economy will grow by 0.4% this year (down from 0.5% they projected in December). Inflation will remain above normal levels through the end of 2023.

Financial markets expected the move, which brings the Fed’s base policy rate to between 4.75 and 5%t.

In the past few months alone, policymakers and economists have shifted their tunes – at times expecting an inevitable recession, no recession, persistently high inflation or an all-out banking catastrophe.

The markets were muted around midday, then rose slightly off the rate hike announcement. The Dow Jones industrial average climbed 40 points, or 0.12%t. The S&P 500 rose 0.36%, and the Nasdaq 0.61%.

Powell said he still saw a path to what’s known as a “soft landing,” when policymakers manage to bring down inflation without causing a recession. But time and again, the Fed’s attempts to look ahead have been thwarted, by a global pandemic and war in Ukraine. Now the rapid interest rate increases of the last year are also contributing to a worrisome degree of instability in the financial system.

The collapses of Silicon Valley Bank and Signature Bank prompted all-out interventions from the Fed and the Biden administration to stave off even bigger problems. The whiplash has focused new attention on financial regulation, especially since SVB imploded despite advance warnings and existing safeguards.

It has also put the Fed – which works hard to maintain its independence – under a harsh political spotlight. Earlier on Wednesday, Sens. Rick Scott, R-Fla., and Elizabeth Warren, D-Mass., unveiled legislation that would replace the Fed’s watchdog with an inspector general appointed by the president and confirmed by the Senate.

For more than a year, Democrats and Republicans have been at odds over the Fed’s policies, with Scott and Warren typically holding opposite views. But scrutiny of the central bank has taken on a new dimension as lawmakers of both parties ask whether the Fed failed in its supervisory duties. That’s coming at the same time that more officials, including Democrats on the Senate Banking Committee, are calling for an end to rate hikes, fearing repercussions for the job market.

“The recent bank collapses and regulatory failures by the Fed have underscored the urgent need for a truly independent Inspector General to hold Fed officials accountable for any lapses or wrongdoing,” Warren said in a statement.

The central bank’s meetings typically revolve around inflation, the job market and whether its approach to slowing the economy is working. The last time Federal Reserve Chair Jerome H. Powell appeared in public two weeks ago, he warned Congress that the central bank was seeing signs the economy was heating back up and might need to be more aggressive raising interest rates.

Perhaps the most consequential part of the day will be Powell’s news conference. He’ll likely get questions on every part of his job: deregulation of banking laws; what the Fed knew about SVB and when; whether he is concerned that more banking shocks are on the horizon; and whether he sees threats from Europe in the wake of Credit Suisses’s forced takeover. (Last week, the European Central Bank moved forward with a half-point rate hike despite the market upheaval.)

He will also be asked to explain whether the Fed’s own interest rate fight is destabilizing parts of the economy, rather than just slowing it down. As the Fed raised rates repeatedly last year, the value of bonds issued at lower interest rates went down. SVB held an unusually high percentage of its assets in Treasury bonds and other long-term instruments that suddenly lost their value, meaning the bank couldn’t easily sell them for what it would have needed to get cash to depositors who wanted to make withdrawals.

Powell will also be asked about the decisions to open a lending program to help keep money flowing through the banking system after SVB failed. On Sunday, the Fed also announced it was coordinating with other major central banks to ease strains in dollar funding markets, a major move that was previously employed in 2020 – when the pandemic started – and 2008, during the financial crisis that led to the Great Recession.