U.S. central bank raises interest rate again

The U.S. Federal Reserve extended its year-long fight against high inflation on Wednesday by raising its key interest rate by a quarter-point despite concerns that higher borrowing rates could worsen the turmoil that has gripped the banking system.

"The U.S. banking system is sound and resilient," the Fed said in a statement after its latest policy meeting ended. 

At the same time, the Fed warned that the financial upheaval stemming from the collapse of two major banks is "likely to result in tighter credit conditions" and "weigh on economic activity, hiring and inflation." 

The central bank also signalled that it's likely nearing the end of its aggressive series of rate hikes. In a statement it issued, it removed language that had previously indicated that it would keep raising rates at upcoming meetings. The statement now says "some additional policy firming may be appropriate."

That's a much weaker commitment than the central bank had made previously.

But the latest rate hike suggests that chair Jerome Powell is confident that the Fed can manage a dual challenge: cool still-high inflation through higher loan rates while defusing the turmoil in the banking sector through emergency lending programs and the Biden administration's decision to cover uninsured deposits at the two failed U.S. banks.

"We have the tools to protect depositors when there's a threat of serious harm to the economy or to the financial system," Powell said Wednesday.

The Fed's move to signal that the end of its rate-hiking campaign is in sight may also soothe financial markets as they continue to digest the consequences of U.S. banking turmoil and the takeover last weekend of Swiss bank Credit Suisse by its larger rival, UBS. 

While clearly signalling it is getting close to the end of a rate hiking cycle that has taken the U.S. federal funds rate to its highest level in 16 years, the Fed made it clear it is still worried about inflation. It said that hiring is "running at a robust pace" and noted that "inflation remains elevated." It removed a phrase, "inflation has eased somewhat," that it had included in its previous statement in February.

The troubles that suddenly erupted in the banking sector two weeks ago likely led to the Fed's decision to raise its benchmark rate by a quarter-point rather than a half-point. Some economists have cautioned that even a modest quarter-point rise in the Fed's key rate, on top of its previous hikes, could imperil weaker banks whose nervous customers may decide to withdraw significant deposits.

Silicon Valley Bank and Signature Bank were both brought down, indirectly, by higher rates, which pummelled the value of the Treasurys and other bonds they owned. As anxious depositors withdrew their money en masse, the banks had to sell the bonds at a loss to pay the depositors. They were unable to raise enough cash to do so. 

After the fall of the two banks, Credit Suisse was taken over by UBS. Another struggling bank, First Republic, has received large deposits from its rivals in a show of support, although its share price plunged Monday before stabilizing.

Some economists worry that a slowdown in lending could be enough to tip the economy into recession. Wall Street traders are betting that a weaker economy will force the Fed to start cutting rates this summer, with as many as three rate hikes by the end of 2023.