US Federal Reserve expected to hike lending rates again despite signs of slowing economy

In an effort to combat excessive inflation, the US Federal Reserve is generally anticipated to raise its benchmark lending rate for the ninth time on Wednesday.

Despite mounting evidence that the US economy is slowing down and widespread predictions that the country would experience a small recession later this year, the US central bank is expected to make this choice.

Analysts and traders anticipate that the Fed would increase interest rates by 25 basis points and then keep them there in an effort to drive inflation back to its long-term aim of 2 per cent without triggering a more severe, painful recession.

“We expect the Fed to hike by 25bp next week and signal a pause in June, with a weak upward bias for rates going forward,” Bank of America economists wrote in a note to clients on Friday.

A further rate hike Wednesday would mark the Fed’s tenth-rate hike in a row, bringing the benchmark to between 5 and 5.25 per cent – its highest level since 2007.

More than 80 per cent of futures traders also expect the Fed to raise interest rates by another 25 basis points, according to data from CME Group.

Banking turbulence

The meeting of the rate-setting Federal Open Markets Committee (FOMC) on May 2 and 3 will be held under very different circumstances than its previous one in March, which took place amid a short, sharp, banking crisis unleashed by the rapid collapse of Silicon Valley Bank (SVB) a few days earlier.

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SVB’s swift demise after it took on excessive interest-rate risk raised concerns of banking contagion, which were amplified by the collapse of New York-based Signature Bank a few days later.

Against the backdrop of the ongoing turbulence in the banking sector, the Fed held off a larger rate hike on 22 March, instead opting for a quarter-point rise.

Concerted efforts by US and European regulators in the aftermath of SVB’s collapse helped calm financial markets and appear to have prevented further high-profile casualties in the banking sector.

“With stress in credit markets easing, Fed officials look set to push ahead with a 25bp rate hike at the early-May meeting,” Oxford Economics’ lead US economist Michael Pearce wrote in a recent note to clients.

But despite calmer financial markets, SVB’s collapse has nevertheless had a lasting impact on the banking sector, with banks tightening lending conditions in the weeks since.

Fed officials have noted that the tighter lending conditions could act like an additional rate hike, possibly reducing the number of hikes necessary to bring inflation back down to two per cent.

Fed governor Christopher Waller said in mid-April that “a significant tightening of credit conditions could obviate the need for some additional monetary policy tightening.”

But he cautioned against “making such a judgment” before good data on the effect of the financial turmoil and bank lending was published.

US regulators admitted on Friday that there was more they could have done to prevent the collapse of both SVB and Signature Bank; the Fed also called for tougher banking rules going forward.

One and done?

Recent US economic data point to a slowing economy, with growing predictions that the US will enter a recession later this year.

Data released in late April showed that economic output slowed to an annual rate of 1.1 per cent in the first quarter of this year, while the Fed’s favoured measure of inflation fell to an annual rate of 4.2 per cent in March, down from 5.1 per cent a month earlier.

The growing impact of the Fed’s campaign of rate hikes on the economy has led analysts and traders to predict the Fed will likely stop raising rates after the decision on Wednesday.

With the quarter-point rise widely expected, the focus next week will instead “be on any changes to the guidance language in the statement,” from the Fed, Deutsche Bank economists wrote in a recent note to clients.

“While our base case remains that the May hike will be the last of this cycle as the economy responds to the tightening to date, we see risks tilted toward another increase in June,” they said in the note.

Fed Chair Jerome Powell suggested after the March interest-rate decision that the Fed could raise rates just once more before bringing its current hiking cycle to an end.

His comments supported the median projection of interest rates for 2023 by FOMC officials.

Minutes of the March FOMC meeting said that the Fed was predicting the US will enter a mild recession later this year when it decided to hike interest rates.

The extent of the recession could depend on how much further the Fed decides to raise interest rates, KPMG senior economist Kenneth Kim wrote in a recent note to clients.

“Any further rate hikes beyond May risk a deeper recession than the mild downturn we currently foresee,” he said.