Fed raises interest rates by 0.25% as banks struggle.

Federal Reserve Announces Target Rate Increase

On Wednesday, officials at the Federal Reserve announced a 0.25% increase in the target federal funds rate, marking a slowdown from previous rate hikes meant to combat inflation. This comes as the financial sector contends with the collapse of three medium-sized regional banks.

What Does This Mean?

Rate hikes increase the cost of borrowing money, decreasing inflationary pressures as consumers and businesses assume less debt but simultaneously slowing the economy. Federal Reserve officials formerly set interest rate targets as low as 0.0% during the lockdown-induced recession to stimulate economic activity; rate targets now sit between 5.0% and 5.25%.

The most recent target rate increase occurs after inflation reached 5.0% two months ago, according to data from the Bureau of Labor Statistics, marking relief from the 9.1% rate seen last summer even as costs for many items remain elevated and wage increases fail to keep pace with price levels.

Impact on the Financial Sector

The rate hike announcement comes days after First Republic Bank collapsed, passed into Federal Deposit Insurance Corporation receivership, and was sold by regulators to JPMorgan Chase. Several other regional banks, including PacWest, Zions, Comerica, and Western Alliance, faced turmoil on the stock market this week as the sector continues to reel from the sudden collapses of Silicon Valley Bank and Signature Bank two months ago.

Interest rate hikes contributed to the substantial loss incurred by Silicon Valley Bank as executives liquidated a long-term bond portfolio to cover withdrawals. Assets in the banking system are $2 trillion lower than their book value as a result of Federal Reserve efforts to implement the current rollback in monetary stimulus, according to a recent study from analysts at the National Bureau of Economic Research.

What’s Next?

Officials at the Federal Reserve concluded that the volatility in the financial system warrants a recession forecast for the end of the year, followed by a predicted recovery over the course of the subsequent two years. Policymakers also estimated that the historically low unemployment rate would rise toward the beginning of next year.

As the Federal Reserve considers future actions to decrease price pressures, they will “take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

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