U.S. central bank to announce latest interest rate decision Wednesday, amid banking crisis

The Federal Reserve is due to announce its latest interest rate policy on Wednesday, a decision much more in doubt than it was just a month ago given the looming crisis in the US banking system.

Most economists watching the US Federal Reserve expect it to raise its benchmark interest rate by another quarter of a point as part of its ongoing campaign to bring inflation into submission.

That would bring the US interest rate to almost 5 percent, its highest level in 16 years.

But events in the financial sector over the past few weeks make that prediction much less certain.

The Silicon Valley Bank (SVB) collapsed earlier this month, propelled into insolvency by a sudden bank run that saw depositors withdraw billions of dollars from the bank in a matter of days, an exodus the bank did not have the funds to to come up with.

The capital crunch that started at SVB was followed by the bankruptcy of another major bank, Signature Bank. A third, First Republic Bank, was saved from collapse by a $30 billion cash injection. More are believed to vary.

Although the causes varied, they share a common theme: the inability to withstand the impact of higher interest rates after investors and depositors were spooked by banks’ finances. The SVB’s troubles began when it had to sell $20 billion worth of government bonds at a loss because the Fed’s rate hikes had made those older, lower-yielding bonds less attractive.

Fighting inflation can have costs

Like many central banks, the Fed has hiked interest rates to bring down inflation, which peaked at over 9 percent last summer.

The latest data suggests that the official US inflation rate has fallen to 6 percent. That’s still double what the Federal Reserve would like to see, so other things being equal, the Fed wouldn’t normally have qualms about raising it again.

But the fear of a banking crisis could make the central bank more cautious.

“Recently, thinking has shifted to how much support the Fed might need to provide to boost confidence in the US banking system and avoid a panic,” said Colin Cieszynski, chief markets strategist at SIA Wealth Management in Toronto.

Just two weeks ago, Federal Reserve Chair Jerome Powell told lawmakers that the central bank was ready to raise interest rates as much as needed to curb inflation — words investors interpreted to mean a big hike 50 points ahead table.

But that was then and that is now. Traders on Wednesday priced in about a two-thirds chance of a small 0.25 percent hike. That means the Fed has a one in three chance of stopping.

Futures markets are even suggesting that the Fed is expected to cut rates as much as three times by the end of this year.

Treasury Secretary Janet Yellen told a banking conference on Tuesday that the situation was “stabilizing” and that the system “remained intact”, but reiterated that the US government would take whatever steps are necessary to ensure depositors’ safety.

Another rate hike would only increase the likelihood of a US lender coming under pressure, leading investors to doubt that the Fed will throw in its money and raise interest rates much higher to wipe out inflation.

“It’s a clear message from several officials that they are not taking this banking turmoil lightly and will likely be proactive when the next big risk comes up,” said analyst Edward Moya of foreign exchange firm Oanda.

The Fed will announce its rate decision at 2pm ET. Chairman Powell will explain the bank’s thinking at a press conference following the announcement.