US Federal Reserve to balance banking woes, inflation in next rate decision

US CENTRAL bankers face an unenviable task when they gather in Washington this week: tackling persistent inflation without adding to financial sector turmoil after Silicon Valley Bank’s (SVB) rapid collapse.

The US Federal Reserve has raised rates eight times since last year in the face of decades-high inflation as it looks to cool the economy without tipping it into a recession.

While Fed chair Jerome Powell earlier signalled willingness to speed up interest rate hikes if needed, most analysts and traders see a small rise of 25 basis points as the most likely outcome on Wednesday (Mar 22) at the end of the Fed’s two-day meeting.

A quarter-percentage-point hike would match the magnitude of the Fed’s last increase in February.

With fears of contagion after the rapid failures of three mid-sized lenders earlier this month, a minority of observers also believe the Fed could halt its rate increases.

A catalyst for the demise of SVB was the Fed’s quick shift from near-zero interest rates to steep hikes, a reversal that swiftly lowered the value of SVB’s holdings linked to long-term US Treasury bonds.

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Given the market turbulence, a bigger 50 basis-point hike is now “off the table”, said Citigroup global chief economist Nathan Sheets.

“My expectation is it’s going to be 25 (basis points) but it’s going to be a debate, and where the markets are on Tuesday and Wednesday is going to be critical,” he said.

SVB’s dramatic implosion this month was the largest banking failure since the 2008 global financial crisis.

The failure of the California high-tech lender on March 10, and the collapse of New York’s Signature Bank a few days later, sparked a rout in regional banking stocks and led many analysts to conclude that the Fed will abandon an anticipated increase in the pace of hikes.

Powell told senators earlier this month that it may be necessary to increase the benchmark lending rate to tame the “widespread” inflationary pressures keeping price rises elevated above the bank’s long-run target of 2 per cent.

Futures traders responded by pricing in a 50-basis-point rise, according to CME Group.

But the financial stress brought to light by SVB’s failure caused a dramatic turnaround in expectations.

The strains in the financial sector will likely have weakened the Fed’s resolve to move more aggressively on Mar 21 and 22, said Bank of America US economist Michael Gapen.

“We think recent events have changed the debate,” he wrote in a note to clients on Mar 17. “We think the debate is now between a 25 (basis points) rate hike in March, or none at all.”

Data for February shows that some corners of the American economy are now beginning to contract – which eases pressure on the Fed – while the consumer price index measure of inflation slowed slightly to an annual rate of 6 per cent.

US retail sales and wholesale prices slipped last month, providing some respite for the Federal Open Market Committee to consider when it mulls another interest-rate hike.

But the Fed’s favoured measure of inflation showed an annual increase in January, suggesting there is still a long way to go before price rises are brought back under control.

Turmoil in the banking sector is not over either, with many regional banks seeing their stocks plunge again at the end of the week despite intervention by US regulators and some of Wall Street’s biggest banks.

“At a minimum, stress in financial markets suggests the Fed should proceed with caution,” said Bank of America’s Gapen. AFP