WASHINGTON — Federal Reserve officials raised interest rates by a quarter-point on Wednesday as officials tried to balance two conflicting problems: the risk that inflation could remain rapid and the threat that higher borrowing costs could fuel turmoil in the banking system.
The Fed on Wednesday pushed interest rates to a range of from 4.75 percent to 5 percent, and it forecast one more rate increase in 2023. In doing so, officials tried to signal that they remained focused on wrestling down price increases and were also paying attention to financial threats.
“In assessing the need for further hikes, we’ll be focused on incoming data and the evolving outlook, and in particular on our assessment of the actual unexpected effects of credit tightening,” Jerome H. Powell, the Fed chair, suggested at his post-meeting news conference.
His comment underlined that the outlook for whether rates would rise further — and, if so, by how much — had been made uncertain by turmoil in the banking industry that could make loans harder to come by, slowing the economy.
At the same time, officials forecast that next year they would lower rates more slowly than they had anticipated, so that rates linger at 4.3 percent by the end of 2024, up from 4.1 percent. That suggested that the fight for stable inflation could be a longer and more gradual one than many had expected even a few months ago.
Stocks, which initially jumped after the Fed’s decision was announced, fell sharply on Wednesday, finishing the day down 1.65 percent as investors balked at the interest rate decision.
Inflation has been surprisingly stubborn, and the job market remains strong, trends that suggest the Fed may have more work to do when it comes to slowing down the economy and wrestling inflation back under control. But high-profile bank failures in recent weeks have underscored the risk that rapid Fed rate moves could stoke financial instability, and might themselves tighten lending and spending conditions in the economy and increase the risk of a recession.
The Fed has been rapidly raising its policy interest rate since March 2022, making it more expensive to borrow money in hopes of cooling spending and eventually weighing down inflation. Officials made four straight three-quarter-point rate increases last year before slowing to a half-point in December and a quarter-point in early February.
Just two weeks ago, many economists and investors thought central bankers might speed their rate moves back up at this meeting because incoming economic data had retained so much momentum — a reality that officials acknowledged on Wednesday.
“Inflation remains too high, and the labor market continues to be very tight,” Mr. Powell said during his post-meeting news conference, later adding, “We’re very focused on getting inflation down.”
At the same time, Fed officials acknowledged that trouble in the banking system could make it harder for consumers to access credit to buy houses or cars, or make other big purchases, weighing on demand and allowing the Fed to adjust interest rates less drastically to cool the economy.
“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’s policy committee said in its post-meeting statement. “The extent of these effects is uncertain.”
While it is clear that the failure of Silicon Valley Bank on March 10, and Signature Bank on March 12, has sent shock waves through the financial system, causing trouble at other banks and prompting a sweeping response from federal regulators, it is unclear how big the effect will be on the economy.
Economists at Goldman Sachs estimate that the effect could be equivalent to the slowdown prompted by one or two Fed rate increases. While others see a much larger impact, Mr. Powell seemed to suggest during his news conference that his estimate — while far from clear — was in that ballpark.
Though turmoil in the banking system did not stop Fed officials from adjusting rates on Wednesday, it did lower their forecasts for how much they would raise borrowing costs this year. Officials projected in December that they would raise interest rates to 5.1 percent in 2023, but then they widely suggested that they were likely to mark those estimates up this month. Inflation had proven harder to crush, and the economy had retained more heat, than most had expected.
Instead, the Fed’s fresh set of economic projections showed that policymakers left their projection unchanged in March, suggesting that they expected to make only one more rate move. Mr. Powell, during his news conference, emphasized the substantial uncertainty around such estimates.
“We are committed to restoring price stability,” Mr. Powell said during his remarks, suggesting that if central bankers needed to raise rates by more, they would.
And while officials did not mark up their rate path for 2023, the fact that officials now expect slightly higher borrowing costs at the end of next year underlines that the process of restoring stable inflation could take a while.
Policymakers now expect rapid price increases to be a more lasting problem, based on their economic estimates. Officials think inflation will finish 2023 at 3.3 percent, up from 3.1 percent in their December projections. That inflation measure was 5.4 percent in January.
Central bankers aim for 2 percent inflation on average over time. While price increases have been slowing from very elevated levels last year — the Fed’s preferred inflation index peaked at about 7 percent last summer — that progress has not been as steady as many hoped.
Continued price increases are weighing on family budgets, and there is a risk that a long period of quick inflation could make price increases a more permanent feature of the American economy.
That is what central bankers are trying to avoid. By lifting rates quickly over the past year, they have hoped to cool growth and bring inflation under control promptly. While brisk monetary policy adjustments increase the risk of financial turmoil and other problems, central bankers have worried that inflation will be harder and more painful to stamp out if it becomes entrenched in daily household and business behavior.
Once people are used to asking for big pay raises to cover climbing costs, and companies are used to making regular price increases, it could take a bigger economic downturn to rewire those habits and change the course of price increases.
“We have to bring inflation down to 2 percent,” Mr. Powell said. “The costs of failing are much higher.”
A critical question is whether the Fed will be able to slow the economy enough to cool inflation without a recession, and Mr. Powell suggested that he still thought such a path was possible — though the recent banking upheaval has not helped.
“I think that pathway still exists,” Mr. Powell said. “We’re certainly trying to find it.”
But Wall Street analysts have pointed out that the risks are greater in a world with financial turmoil. Problems in the banking sector can easily spill over to hit Main Street, as ordinary people and businesses struggle to access borrowed cash.
“You have the trigger that can make it into a deeper recession — can make it into a hard landing,” said Priya Misra, the head of global rates strategy at TD Securities.
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