Another US money house collapsed – this time it hit the First Republic Bank. Will the Fed continue to tighten interest rates? It’s a tightrope act for the central bank.
In its fight against high inflation, the US Federal Reserve is about to raise its key interest rate for the tenth time in a row. The Federal Reserve (Fed) is expected to hike interest rates by another 0.25 percentage point this Wednesday, to a range of then 5 to 5.25 percent. That would be the highest value in 16 years.
Experts believe that the latest bank collapse – the collapse of the First Republic Bank – will not stop the Fed’s decision-makers from further tightening interest rates. The big question now is whether Fed Chair Jerome Powell will hold out the prospect of a rate pause.
Smaller rate hikes recently
When making its decision, the Fed must weigh up the balance between calming concerns in the banking sector and fighting high consumer prices. In the past year, the Fed had raised interest rates by an impressive 0.75 percentage points several times. The Fed had thus set a pace that it had not seen in decades. She initiated this turnaround in interest rates a good year ago – at that time the key interest rate was almost zero.
Most recently, however, the central bank opted for smaller rate hikes. As early as March, the Fed opted for a rate hike of 0.25 percentage points. The Fed’s forecast now signals at least one further increase in key interest rates for this year.
High consumer prices are proving persistent in the US. In its most recent forecast from March, the Fed expects an average inflation rate of 3.3 percent for this year. The high level of inflation in the USA had recently weakened more than expected. In March, consumer prices rose by 5.0 percent compared to the same month last year. It was the lowest increase since May 2021. But both that reading and the full-year forecast are still a long way from the Fed’s target inflation rate of 2 percent on average.
turbulence in the banking sector
Keeping inflation in check is the traditional task of central banks. If interest rates rise, private individuals and the economy have to spend more money on loans – or borrow less money. Growth is slowing, companies cannot simply pass on higher prices – and ideally the inflation rate is falling. After the last meeting, Powell emphasized that the turbulence in the banking sector could have a similar effect on lending. However, this also increases the risk that the economy will be slowed down.
Some of the turmoil in the banking sector has come from the Fed’s aggressive rate hikes. With the First Republic Bank, another struggling US money house is at an end. It was announced Monday that industry leader JP Morgan Chase was taking over the troubled bank in a government-coordinated bailout. After the collapse of Silicon Valley Bank and Signature Bank in March, it initially seemed as if the turbulence had passed.
Strong labor market drives inflation
The Fed must now manage a balancing act in its monetary policy – further significant interest rate hikes could unsettle the market. At the same time, the labor market remains robust. What actually sounds good, however, can drive up consumer prices even further. Because a strong labor market is generally seen as a driver for wages and thus for inflation. It is therefore unclear whether Fed Chairman Powell will really commit to an interest rate pause at the upcoming meetings.
“The worst case scenario for (the Fed) would be to signal that it’s done and then be forced by the data to do a U-turn,” the New York Times quoted Blerina Uruci of the US fund company T. RowePrice. It seems clear that the Fed has no plans to cut interest rates, at least for the foreseeable future. Instead, it is likely to keep high interest rates steady for a few months and only then slowly start lowering them. Interest rate cuts as early as the summer, which some had speculated on, are probably off the table with the Fed’s latest forecasts.