Despite banking crisis, the US increases interest rates

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Despite banking crisis, the US increases interest rates.

Despite concerns that the move could lead to further financial turmoil following a series of bank failures, the US central bank has raised interest rates again. The Federal Reserve increased its key rate by 0.25 percentage points, citing a “sound and resilient” banking system.

However, the Fed also cautioned that fallout from the recent bank failures could impact economic growth in the near future. The Fed has been steadily increasing borrowing costs in an effort to stabilize prices, but the sharp rise in interest rates since last year has put pressure on the banking system.

This pressure is evidenced by the collapse of two US banks, Silicon Valley Bank and Signature Bank, this month, which were partially due to problems caused by higher interest rates. Additionally, there are concerns that the value of bonds held by banks may decrease as interest rates rise, which could cause further strain on the banking system.

Banks typically hold large bond portfolios, leaving them vulnerable to potential losses if the value of those bonds falls. However, such declines only become problematic if banks are forced to sell the bonds.
Regulators worldwide have expressed confidence that the recent bank failures do not pose a significant threat to overall financial stability, and efforts to control inflation should not be derailed.
The European Central Bank recently raised its key interest rate by 0.5 percentage points, and the Bank of England is set to make its own interest rate decision shortly after official figures revealed an unexpected rise in February’s inflation rate to 10.4%.
Federal Reserve Chairman Jerome Powell reiterated that the Fed is committed to combating inflation and stated that Silicon Valley Bank is an “outlier” in an otherwise robust financial system.

Impacts on the economy

The Federal Reserve has released forecasts showing that the US economy is projected to grow only 0.4% this year and 1.2% in 2024, marking a significant slowdown from previous years and lower than officials had projected in December.

The announcement from the Fed also suggests a toned-down approach to earlier statements, which had indicated that ongoing increases in interest rates would be necessary in the coming months. Instead, the Fed stated that “some additional policy firming may be appropriate.” This shift “clearly signals that the Fed is nervous,” according to Ian Shepherdson, chief economist at Pantheon Macroeconomics.

The Federal Reserve’s rate rise on Wednesday is the ninth in a row, bringing its key interest rate to 4.75%-5%, the highest level since 2007, up from near zero just a year ago. Higher interest rates lead to increased costs for borrowing, making it more expensive to buy a home or expand a business, and reducing demand in these areas, which helps to cool prices.
Getty image
Getty image
While purchases in the US housing market have slowed over the past year, prices in general continue to climb faster than the 2% rate considered healthy, with inflation jumping 6% in the 12 months to February. Some items, such as food and airfare, have seen even faster surges in cost. Nonetheless, the overall economy has held up better than expected.
The Federal Reserve, under the leadership of Mr Powell, had earlier warned that it may need to increase interest rates more than anticipated to bring the situation under control.
However, the bank projections now indicate that policymakers expect inflation to fall this year, albeit less than previously anticipated.
They predict interest rates to hover around 5.1% by the end of 2023, which implies that the Fed is likely to stop raising rates soon. Despite the recent financial turmoil that could slow down the economy, Mr Powell reaffirmed that the Fed will not shy away from its fight against inflation, adding that the costs of not doing so are much higher.

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