The Federal Reserve hiked interest rates by 0.25 percentage points on Wednesday after numerous failures in the banking sector had prompted some analysts on Wall Street to call for a pause.

The quarter-point hike is the ninth consecutive rate increase by the Fed since March of last year as part of the U.S. central bank’s program of quantitative tightening undertaken in response to high inflation. The Fed’s baseline interest rate range is now set to 4.75 to 5 percent.

The move shows that the Fed’s first priority remains bringing down elevated price levels, even as the bank’s rate increases have strained portfolios in the banking sector, triggering some poorly managed banks to collapse.

Fed chair Jerome Powell said during a press conference on Wednesday that the U.S. banking system was “sound and resilient” and that deposit flows have stabilized over the past week.

However, he did say that members of the bank’s rate setting committee did consider take a pause on rate hikes.

“We did consider that in the days running up to the meeting,” he said, adding that “the inter-meeting data on inflation and the labor market came in stronger than expected and really before the recent events, we were clearly on track to continue with ongoing rate hikes.”

“The events of the last two weeks are likely to result in some tightening of credit conditions for households and businesses,” Powell said, noting that this tightening “would work in the same direction as rate tightening in principle.”

New forecasts by the Fed put the terminal interest rate for 2023 at 5.1 percent, the same as the forecast made in December. The Fed revised the projected unemployment rate for this year down to 4.5 percent to 4.6 percent, which is still much higher than the current rate of 3.6 percent.

The bank also expects inflation to remain higher this year than previously anticipated, with the personal consumption expenditures (PCE) price index to land at 3.3 percent annually, up from 3.1 percent predicted in December.

Federal Reserve Chairman Jerome Powell
Federal Reserve Chairman Jerome Powell discusses his semiannual Monetary Policy Report to Congress before the Senate Banking, Housing, and Urban Affairs Committee on Tuesday, March 7, 2023.

Inflation has been falling but is still high

Price growth as measured in the consumer price index (CPI) and personal consumption expenditures (PCE) price index have been coming down since the middle of last year but are still well above the Fed’s target rate of 2 percent.

The PCE ticked up to 5.4 percent annually from 5.3 percent for the first time in several months in January, leading some analysts to call for a larger 0.5 percentage point increase this month by the Fed.

Concerns about the banking industry took the larger hike off the table earlier this month.

Inflation in the economy hasn’t occurred across the board in the aftermath of the coronavirus pandemic but has been concentrated in different sectors at different times.

An initial inflation in durable goods and autos has since dissipated, along with commodity inflation following the escalation of the war in Ukraine, while inflation in the housing sector remains a primary driver of the elevated headline numbers. 

“We still don’t have now … a sign of progress in the non-housing services sector,” Powell said Wednesday. “The inflation data that we got … really pointed to stronger inflation.”

“These things have really had their own separate timing and their own separate dynamics. It’s very hard to argue that any of these are just your standard demand-driven inflation,” economist J.W. Mason of the City University of New York said during an event earlier in March.

Traders on the floor at the New York Stock Exchange watch Federal Reserve Chair Jerome Powell’s news conference after the Federal Reserve interest rate announcement in New York, Wednesday, Feb. 1, 2023.

Bankers had been calling for a pause

Some Fed policy prediction algorithms put the chances of a 0.25 percentage point rate hike as high as 86 percent on Tuesday, but many analysts had still been calling for a break in the hikes ahead of the Fed’s decision this week.

“Bank stress calls for a pause,” analysts for Goldman Sachs wrote in a Monday research letter to investors, arguing that banking is more important than other sectors of the economy.

“Banking is not just another sector of the economy because financial intermediation is vital to every sector. As a result, addressing stress in the banking system is the most immediate concern and must take priority over other less urgent goals for the moment. We expect that policymakers and staff economists at the Fed will have the same view,” they wrote.

Other influential commentators agreed.

“The banking mess is, as far as I can tell, sufficient reason for the Fed to pause until we know more,” economist Paul Krugman wrote online.

Silicon Valley Bank
Security admits a man to the lobby as customers queue up outside the collapsed Silicon Valley Bank in Santa Clara, Calif., on March 13, 2023. President Biden assured Americans that the U.S. banking system is safe.

Backdrop of failed banks

The Fed decision comes after a series of bank failures over the past week-and-a-half prompted government intervention to prop up the banking sector and placate volatile markets.

The spark was lit by the collapse of Silicon Valley Bank (SVB), where a run by rich depositors largely from the venture capital sector led to insolvency. The bank couldn’t pay depositors because their money was tied up in longer-term bonds that hadn’t yet come to maturity and are sensitive to interest rate hikes. 

The Federal Deposit Insurance Corporation (FDIC), Fed and Treasury responded by insuring all deposits at the bank above the standard $250,000 limit, using money from the FDIC’s deposit insurance fund as well as a new line of credit from the Fed backed up by $25 billion of taxpayer money.

Powell said Wednesday that he will welcome the findings of investigations into the recent bank failures, one of which is being undertaken outside the Fed by the Department of Justice. Lawmakers have called for separate investigations by the inspectors general at the FDIC, Fed and Treasury.

“This was a bank that was an outlier,” Powell said of SVB. “Supervisors did get in there and … they were on this issue, but nonetheless this still happened.”

Markets responded positively to the government’s move to bailout SVB’s depositors last Monday but were falling fast by the middle of the week on fears of yet more failures.

Another California-based bank, First Republic, was poised to collapse before Treasury Secretary Janet Yellen reportedly leaned on JPMorgan Chase chief Jamie Dimon to organize a private-sector bailout, corralling a consortium of 11 banks to pony up $30 billion.

While technically a deposit executed at a market rate, the move drew criticism from some investors as ostensibly an act of charity compelled by pressure from the government. 

“The [systemically important banks] would never have made this low return investment in deposits unless they were pressured to do so and without assurances that [First Republic Bank] deposits would be backstopped if it failed,” billionaire investor Bill Ackman wrote online last Thursday.

It isn’t known if Ackman held a commercial position in First Republic.

Meanwhile, European giant Credit Suisse failed after Saudi investors declined to increase their investment in bank, leading to an appeal to the Swiss National Bank and eventually a shotgun sale to rival UBS.

JPMorgan Chase & Co. Chairman and CEO Jamie Dimon
JPMorgan Chase & Co. Chairman and CEO Jamie Dimon answers questions during a House Financial Services Committee oversight hearing of the largest U.S. banks on Wednesday, September 21, 2022.

Fed’s balance sheet has spiked 

Independent of the move on rate hikes, the Fed’s balance sheet has rocketed up over the past week, already potentially stalling the Fed’s tightening program.

The balance added more than $300 billion in assets over the course of last week, jumping up from $8.34 trillion to $8.64 trillion.

“Amid the failures, banks borrowed $153 billion from the primary credit discount window … and another $12 billion via the new Bank Term Funding Program,” analysts for Deutsche Bank wrote in an analysis last week. 

They pointed out the  Fed also provided $143 billion of liquidity to the 2 FDIC-owned bridge banks set up after the closures of SVB and Signature Bank. 

“By district breakdown, San Francisco (+$233 billion ) and New York ($55 billion) had the biggest increases in securities and loans portfolios. Despite record activity at the discount window, total Fed liquidity borrowed was still a fraction of peak liquidity provided during the [global financial crisis] and Covid,” they wrote.

The public is disapproving of bank bailouts

While the Fed’s actions over the past week may prove enough to save the banking industry from a wider collapse, Americans overwhelmingly agree that taxpayers should not have to bail out banks that can’t properly manage themselves.

A new public opinion poll by Ipsos found that 84 percent of Americans agree – and 56 percent agree strongly – “that taxpayers should not have to foot the bill for irresponsible bank management.” The frustration is bipartisan, with 85 percent of Democrats and 86 percent of Republicans in agreement.

Less than half of Americans are in favor of government bailouts of U.S. financial institutions at 49 percent, the poll found.