Turmoil in the banking system after two major banks collapsed led many Federal Reserve officials to envision fewer rate increases this year out of concern that banks will reduce their lending and weaken the economy.
The heightened uncertainty surrounding the banking sector also helped Fed officials coalesce around their decision to raise their benchmark rate by just a quarter-point, rather than a half-point, despite signs that inflation was still too hot, according to minutes of the Fed’s March 22-23 meeting.
The Fed also revealed Wednesday that its staff economists have forecast that a pullback in lending resulting from the banking turmoil will cause a “mild recession” starting later this year. The minutes noted that this forecast depends on how severe the consequences of the industry’s troubles prove to be and to what extent it will cause a cutback in lending.
Overall, the minutes showed that the banking troubles injected significant uncertainty into the Fed’s decision and reversed an emerging trend to keep raising rates aggressively to quell inflation. At their meeting last month, Fed officials projected that they will raise their key short-term rate — which affects many consumer and business loans — just once more this year, at their May meeting.
Before the collapse of Silicon Valley Bank, many officials said they had expected to forecast more than just one additional hike this year because economic and inflation data showed that the Fed still had more to do to control the pace of price increases. Instead, Fed officials agreed that the collapse of the two large banks “would likely lead to some weakening of credit conditions,” as banks sought to preserve capital by curtailing lending to consumers and businesses.
Government Reduced Banking Risks
Several officials said they had considered supporting leaving rates unchanged at last month’s meeting. But they added that actions by the Fed, the Treasury Department and the Federal Deposit Insurance Corp. had “helped calm conditions” in banking and reduced the risks to the economy in the short run.
Some other officials said they had favored a half-point hike last month because hiring, consumer spending, and inflation data still pointed to a hot economy. But given the uncertainty resulting from the banking troubles, they “judged it prudent” to implement a smaller quarter-point increase.
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