Fed hikes interest rate by 0. 25 point to curb inflation; banking crisis might snowball

The US Federal Reserve on March 22 announced a quarter point-hike in interest rates, refusing to lower guard on a persistently high inflation but assured markets battered by a banking crisis that it has enough firepower to avert a contagion.

The Fed increased its funds target rate to a range of 4.75-5 percent, a level last seen prior to the 2007-08 global financial crisis.

The hike in rates, which came broadly on the expected lines, will further add to the cost of funds and refuel the risks of a potential recession that will have rippling effects not only in the world’s largest economy but elsewhere on the globe. The rate hike was necessitated by a sticky high inflation.

The Fed, in its statement, noted that the US banking system is “sound and resilient”, but the recent developments in the banking sector “are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation”.

Fed policymakers projected rates would end 2023 at about 5.1 percent, unchanged from their median estimate from the last round of forecasts in December. The median 2024 projection rose to 4.3 percent from 4.1 percent.

The hike and forecasts suggest policymakers remain firmly focused on bringing down inflation to their 2 percent goal, indicating they see rising prices — especially based on recent data — as a bigger growth threat than the bank turmoil. It also projects confidence that the economy and financial system remain healthy enough to withstand the string of bank collapses.

The Fed action came days after Silicon Valley Bank and at least two other regional banks failed after mounting losses on their bond portfolio and large-scale fund withdrawals from depositors cracked their balance-sheets, forcing regulators to shut down these entities.

The banking crisis kicked off a major sell off across stock markets and somewhat triggered the downfall of global banking major Credit Suisse which was merged with UBS in a Swiss-government brokered deal.

The Fed assured markets that it has enough firepower to handle the banking crisis and reiterated that the broader banking sector is reinforced with adequate safeguards in terms of capital adequacy. In the aftermath of the Credit Suisse debacle, global central banks led by Fed had announced a dollar swap facility to ensure enough liquidity in the system.

The Fed’s rate hike will have ramifications on the policy rates of other central banks including the Reserve Bank of India (RBI), whose Monetary Policy Committee (MPC) is set to meet in April to decide the next course of policy action.

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