Fed Keeps May Interest-Rate Increase on Table Despite Expected Recession

Officials thought regulators had soothed banking turmoil enough to justify a quarter-point rate increase, meeting minutes show.

Courtesy of By Nick Timiraos, Wall Street Journal

Stubbornly high inflation and tight labor markets led Federal Reserve officials to signal they could raise interest rates at their next meeting despite a greater likelihood of a recession later this year.

The fallout from the failures of two midsize banks led Fed officials to consider skipping a rate increase at their meeting last month, but they concluded regulators had calmed stresses enough to justify a quarter-point rate rise, according to minutes of the March 21-22 gathering released Wednesday.

For the first time since officials began lifting rates a year ago, the Fed staff forecast presented at the meeting anticipated a recession would start later this year due to banking-sector turmoil, the minutes said. Previously, the staff had judged a recession was roughly as likely to occur as not this year.

Looking ahead, the minutes hinted at potential policy divisions, with some officials pointing to greater risks of a sharper-than-anticipated slowdown and others highlighting the prospect of firmer inflation this year.

Officials concluded that given the strength of price pressures and the demand for labor, “they anticipated that some additional policy firming may be appropriate” to bring inflation down to the central bank’s 2% goal, the minutes said. They also said they would pay close attention to bank lending conditions as they weigh their next move.

The latest rate rise brought the Fed’s benchmark federal-funds rate to a range between 4.75% and 5%. All 18 officials who participated in last month’s meeting supported the increase, the minutes said. New economic projections released then showed nearly all expected they would lift rates one more time this year. Most of them expected to hold rates steady after that, provided the economy grows little this year and labor demand cools.

Over the past year, the Fed has raised rates at its fastest pace since the early 1980s to combat inflation that jumped to a 40-year high last year. Until recently, officials had signaled that they were likely to keep raising lifting rates until they saw more conclusive evidence that economic activity and price increases were slowing.

The rate outlook became much more uncertain after banking-system stresses flared last month, beginning March 9 when panicked depositors pulled money from Silicon Valley Bank, which regulators closed the following day. Regulators closed a second institution that also faced a run, Signature Bank, on March 12 and intervened aggressively to shore up confidence in the banking system.

Many Fed officials anticipated “there would be some tightening of credit conditions, and that would really have the same effects as our policies do,” Fed Chair Jerome Powell said at a news conference March 22. “If that did not turn out to be the case, in principle, you would need more rate hikes.”

Inflation moderated somewhat last month, the Labor Department said Wednesday. The consumer-price index rose 0.1% in March and by 5% over the previous 12 months, the smallest annual increase in nearly two years. But core prices, which exclude volatile food and energy items and which central bankers see as a better gauge of underlying inflation, rose 0.4% in March and by 5.6% over the previous year, up from 5.5% in February.

The Fed fights inflation by slowing the economy through raising rates, which causes tighter financial conditions such as higher borrowing costs, lower stock prices and a stronger dollar, which curb demand.

“While the full impact of this policy tightening is still making its way through the system, the strength of the economy and the elevated readings on inflation suggest that there is more work to do,” San Francisco Fed President Mary Daly said in a speech Wednesday.

The question ahead of the Fed’s May 2-3 meeting is whether officials place more emphasis on anecdotes and surveys of credit conditions if they signal a pullback in lending, which could call for forgoing an increase or raising rates while signaling a pause, or whether they place more weight on economic data that might show less effect on credit availability but be more dated.

Philadelphia Fed President Patrick Harker said Tuesday he has long anticipated the central bank would need to raise the fed-funds rate above 5% “and then sit there for a while.”

Last year, supply-chain healing offered a compelling reason to think price growth would slow. This year, the case for inflation falling depends more squarely on declines in the demand for labor and consumer spending. “If you don’t see demand moving [down], it is hard to envision how you think inflation is going to” slow, Richmond Fed President Tom Barkin told reporters on March 30.

“You have to have a theory of why inflation’s going to come down if you think it is going to come down,” he said.