The US Federal Reserve raised its interest rates by a quarter percentage point on Wednesday, putting them in the 5.0 per cent-5.25 per cent range. It’s the Fed’s tenth consecutive increase since March 2022, soon after Russia’s invasion of Ukraine. But the announcement was accompanied by an indication investors had long awaited about the possibility of the interest hikes nearing their end.
Rather than its standard comment of recent months, saying that it “anticipates” that further rates increases will be necessary in the near-term, the Fed on Wednesday instead said that it would monitor incoming data to determine whether more increases “may be appropriate.”
Although that comment falls far short of a guarantee, it’s the first time in months the Fed has watered down what used to be a warning that investors and business should price in more increases in the short-term.
Still, Fed chair Jerome Powell also stressed on Wednesday that “we are prepared to do more,” if it appears to be necessary. He said this call would be made on a “meeting-by-meeting” basis.
The US central bank also noted that “inflation remains elevated” and job gains are still “running at a robust pace” in its report, two factors that might convince it of the need for further action at its next policy meeting in June.
Debt ceiling standoff another potential factor?
That meeting could potentially be overshadowed by the stalemate between the White House and the Republican-led House of Representatives on raising the US’s public borrowing limit.
Janet Yellen, a former Fed chair and now the Treasury Secretary, recently warned that, if unresolved, this could leave the US unable to meet its debt repayment commitments as soon as next month.
Analysts have pointed to rates increases, and the resultant devaluation of long-term bonds on debt that were agreed at far lower rates of interest, as a major factor in the collapse of three US banks, First Republic this week, and Silicon Valley Bank and Signature Bank in March
Current Fed Chair Jerome Powell also addressed the issue on Wednesday when explaining the rates decision, saying his organization is unlikely to be able to shield the US from a technical default if the politicians fail to reach a deal.
“We don’t give advice to either side,” Powell said. “We would just point out that it’s very important that this be done. But the other point I’ll make about that, though, is that no one should assume the Fed can protect the economy from the potential, you know, short and long term effects of a failure to pay our bills on time.”
Increasing interest rates to counter inflation
Central banks’ so-called benchmark interest rates are the rates they charge commercial lenders to borrow money.
They are different to, and usually quite a bit lower than, the rates people pay on their mortgages or loans or personal debt. They are also usually quite a bit higher than the rates ordinary savers can hope to receive for money they deposit at their bank. But despite this, they tend to have a direct impact on these rates.
After years of unprecedented benchmark rates near zero — never seen prior to the financial crash of 2008/2009, but virtually the norm in most Western economies ever since then — central banks have been rushing to raise interest rates ever since first the Covid-19 pandemic and then Russia’s invasion of Ukraine started pushing long-flat lining inflation figures skywards.
Raising interest rates is seen as a way to try to rein in inflation, by discouraging borrowing and therefore spending.
The Fed received credit for seeing this trend coming slightly earlier than others and responding more quickly. The eurozone’s European Central Bank did not touch its benchmark rates until July 2022, four months after the Fed’s first response.
Inflation was less pronounced in the US than in most of Europe last year, although other factors besides monetary policy — not least Europe’s proximity to Russia and Ukraine and increased trade with both countries — play a part in this.
Pressure on banking sector
Another factor pressuring the Fed to consider halting its recent course of what economists sometimes call “monetary tightening” is the stability of the banking sector.
Analysts have pointed to rates increases, and the resultant devaluation of long-term bonds on debt that were agreed at far lower rates of interest, as a major factor in the collapse of three US banks, First Republic this week, and Silicon Valley Bank and Signature Bank in March.
Many banks invest heavily in such bonds, often but not exclusively in government debt, but they have fixed rates of returns over periods of up to 10 years — and those issued prior to the rates increases now have yields that are much lower than the benchmark interest rates.